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Struggling with AMT/Dividend Tax Efficiency
Old 05-07-2015, 11:26 AM   #1
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Struggling with AMT/Dividend Tax Efficiency

In recent years my wife and I have become subject to AMT. This caused me to run our 2014 taxes both with and without our brokerage account dividend income to understand how our dividend income is impacting our overall tax liability. It turns out we're paying close to 30% effective tax rate on our dividend income due to its interaction with AMT.

I've historically held most of my foreign ETFs in our brokerage account to benefit from the foreign taxes paid, while holding most domestic stocks in tax-sheltered retirement accounts. The problem I'm seeing is that foreign stocks are currently paying higher dividend rates (close to 3% in total), which is increasing our dividend income and thus AMT liability.

Based on a quick review of tax scenarios it looks like I would be better off moving some of the higher dividend-paying foreign holdings to my retirement accounts (thus forgoing the foreign tax credit) and moving some of the lower dividend-paying domestic holdings (ie, small caps and growth) to my brokerage account to reduce overall dividend income. The decrease in dividends (and thus tax liability) appears to be greater than the loss of the foreign tax credit.

In addition to shifting some of my domestic/foreign holdings around, I'm leaning towards increasing my Berkshire and commodity holdings (currently held in brokerage) since they don't throw off dividends.

Has anyone else dealt with this issue? Am I missing anything in my thinking? I'm having a hard time finding foreign ETFs with low dividend yields, which would help.
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Old 05-07-2015, 11:28 AM   #2
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I also should have noted that I am still working, and plan to for perhaps another 10 years...
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Old 05-07-2015, 01:20 PM   #3
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Here is a list of S&P500 stocks that don't pay dividends if you believe dividends do not offer value. You could equal weight the entire list to create your own non-dividend paying S&P 500 fund, rather than only the one Berkshire Hathaway. Congratulations on earning enough money to have AMT be a matter of avoidance.

S&P 500 Companies without Dividends

You could also get a subscription to Value line and download a list of all of the 1700 Value Line stocks that do not pay dividends, and create an equal weight portfolio from that list. There is a relatively large number of stocks in that index that do not pay dividends, most of setting up the portfolio would only be your commission of $6.00 or so per share so expenses would be very low and maintaince would only require monitoring if they start paying a dividend, if a new non-dividend payer joined the index of if they were dropped from the index.

Of course if your ETF is paying a 1.8% dividend like VTI a 30% tax on the dividends reduces your return by only .54 percent, and if you are ok with a 15% tax rate then the additional tax you are avoiding is only a 0.27% fee. I think personally it is possible this universe of non dividend paying stocks underperforms the remainder of the dividend paying market by more than that, beyond that I never let tax consequences drive my investment decisions.
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Old 05-07-2015, 01:30 PM   #4
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Originally Posted by bots2019 View Post
Has anyone else dealt with this issue?
I also have my foreign funds in retirement account for this reason. Loss of foreign tax credit is compensated by shielding higher dividends and higher percentage of nonqualified dividends.
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Old 05-07-2015, 04:02 PM   #5
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Quote:
Originally Posted by bots2019 View Post
In recent years my wife and I have become subject to AMT. This caused me to run our 2014 taxes both with and without our brokerage account dividend income to understand how our dividend income is impacting our overall tax liability. It turns out we're paying close to 30% effective tax rate on our dividend income due to its interaction with AMT.

I've historically held most of my foreign ETFs in our brokerage account to benefit from the foreign taxes paid, while holding most domestic stocks in tax-sheltered retirement accounts. The problem I'm seeing is that foreign stocks are currently paying higher dividend rates (close to 3% in total), which is increasing our dividend income and thus AMT liability.

Based on a quick review of tax scenarios it looks like I would be better off moving some of the higher dividend-paying foreign holdings to my retirement accounts (thus forgoing the foreign tax credit) and moving some of the lower dividend-paying domestic holdings (ie, small caps and growth) to my brokerage account to reduce overall dividend income. The decrease in dividends (and thus tax liability) appears to be greater than the loss of the foreign tax credit.

In addition to shifting some of my domestic/foreign holdings around, I'm leaning towards increasing my Berkshire and commodity holdings (currently held in brokerage) since they don't throw off dividends.

Has anyone else dealt with this issue? Am I missing anything in my thinking? I'm having a hard time finding foreign ETFs with low dividend yields, which would help.
I also have this issue that I struggled with.

To figure out my optimal solution, I created two charts in Excel, with fields for foreign tax rate, current and future tax rates, and dividend yield, and then compared which combination had the highest after-tax results for having one holding in taxable/traditional IRA/ROTH IRA.

My rule-of-thumb (based on the specific holdings I have and their yields): if a stock has a qualified dividend-equivalent yield of 4% or more, it goes in my IRAs. (so if the dividend is not qualified, the cut-off is 2%, since I pay roughly as much in taxes on a 4% qualified dividend as I do on a 2% non-qualified). If it's part-qualified, part-non-qualified, I do a weighted-average with the tax rates to determine the equivalent.

If a high yielder above my cut-off has a foreign tax withholding of 10% or less, i'll hold it in my tax-deferred accounts and forego the tax-deduction. but if the foreign tax bite is more than 10% (France and another country have an insane rate of like 30%!!!), then I keep it in taxable.

Also, within my ROTH/non-ROTH IRA, it's not just yield, but also relative risk. Because my ROTH is tax-free, I want it to have the least chance of losses, since at least if I have a loss in my Traditional IRA, it means I pay less income taxes upon withdrawal. A loss in my ROTH is forever gone and there is no partial benefit of that loss.

In general, you want your highest yielders in your ROTH...but you also have to balance that with (IMO) your safer holdings as well. So depending on your confidence in it, you might put the highest yielders in your traditional IRA, with the "middle pack" yielders in your ROTH.
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