Our Best Idea: Qualified Dividend Income (QDI) Securities

The recent increase in top ordinary income tax rates from 35% to 39.6% has reinforced the importance of a tax efficient investment strategy. Some dividends are taxed at a much more favorable rate than interest income. A tax efficient fixed income strategy would favor the dividends that qualify for the lower rate. Dividends taxed at the lower rate are called “Qualified Dividend Income” (QDI). The following table compares interest income tax rates and the tax rates for QDI securities.

Single filers above $250,000 and joint filers above $300,000 must also face the phase out or limitation of itemized deductions, which typically increases their tax rates by about 1%. Adding up all the taxes for the highest income earners (taxable income, medicare tax, and the limitation on itemized deductions), the marginal tax rate on interest income versus QDI eligible securities would be 44.6% compared to only 24.8%, respectively. Given this gap, we are over-weighting taxable portfolios with QDI eligible securities to improve after tax yields.

Individual Income Tax Rates for 2013
Taxable Income*		Ordinary Income (Interest Income)	Qualified Dividends	Medicare Tax
Single	Joint			Earned Income**	Investment Income
0+	0+	10%	0%	2.90%	0%
$8,950	$17,900	15%
$36,250	$72,500	25%	15%
$87,850	$146,400	28%
$183,250	$223,050	33%
$200,000+ (AGI)	$250,000+ (AGI)			3.80%	3.80%
$398,350+	$398,350+	35%
$400,000+	$450,000	39.60%	20%
*Based on estimated 2013 inflation adjustments. Amounts refer to taxable income except where noted **Combined rate includes 1.45% employer contribution

For example:

A). At $150,000 of joint income, ordinary income, such as interest income, the tax rate is 30.9% whereas income derived from QDI dividends is 15.0%.

B). At $275,000 of joint income, ordinary income tax is 36.8% whereas income derived from QDI dividends is 18.8%.

C). At $475,000 of joint income, ordinary income tax is 44.6% whereas income derived from QDI dividends is 24.8% (when you include the projected increase of 1% because of the limitation on itemized deductions for both estimates).

1. http://online.wsj.com/article/SB10001424127887323820104578216092043022764.html

*The information contained in this commentary is not investment advice for any person. It is presented only for informational purposes to assist in explaining factors that may have had an impact in the past or may have an impact in the future on client portfolios or composites. All expressions of opinion reflect the judgment of the firm on this date and are subject to change. Included information has been obtained from sources considered reliable, but we do not guarantee that the foregoing materials are accurate or complete. Clients or prospective clients should contact Ulland Investment Advisors for individualized information prior to deciding to participate in any portfolio or making any investment decision. Ulland Investment Advisors does not provide tax advice. All clients are strongly urged to consult with their tax advisors regarding any potential investment. Past performance does not guarantee future results; there is always a possibility of loss.