Phoebe Venable: Changing your investment portfolio could create tax liability

At this time of year, much thought and consideration are given to taxes. For many professionals, this is “tax season,” just as it is for individuals beginning to gather the needed documentation to prepare their 2013 income tax returns.

Living in Tennessee, we are fortunate there is no state income tax; however, the state does levy a tax on interest and dividend income over certain amounts. This tax is commonly called the Hall income tax. Enacted in 1929, it can be found in Tennessee Code Annotated in Title 67, Chapter 2.

The Hall income tax applies to individuals, partnerships, associations and trusts that are legally domiciled in Tennessee and have taxable interest and dividend income exceeding $1,250 ($2,500 if married, filing jointly) during the tax year. A person who has moved into or out of Tennessee is subject to the tax if they earned $1,250 ($2,500 if married, filing jointly) during their period of residency. For Tennessee partnerships, associations and trusts earning taxable interest and dividend income exceeding $1,250, they also are liable for this tax.

There are exemptions. For the 2013 tax year, any person 65 years of age or older having a total annual income derived from any and all sources of $33,000 or less ($59,000 or less for joint filers) is completely exempt from the tax. Total annual income includes Social Security income, regardless of whether the income is taxable for federal purposes. If you are not completely exempt from the tax because your income is higher, you still get an exemption, as the first $1,250 ($2,500 if married, filing jointly) of taxable interest and dividend income is exempt.

The Tennessee Individual Income Tax Return (note there is no mention of “Hall tax”) walks the filer through taxable dividends and interest versus non-taxable dividends and interest. The non-taxable category includes interest from all Tennessee municipal bonds and U.S. government and government agency bonds, as well as interest from credit unions, certificates of deposit and most bank accounts, including checking, savings, NOW accounts, money market accounts, etc. Dividends from national and Tennessee-chartered banks, savings and loan associations and insurance companies are also considered non-taxable. The tax rate is 6 percent and, for individuals, the tax is due on April 15.

Bill would cut tax

This tax, essentially an investment tax, has been the subject of much debate and many years of speculation regarding repeal. This week, Grover Norquist, president of Americans for Tax Reform, sent a letter to our state representatives and senators urging them to support S.B. 1427, introduced by Sen. Mark Green, which would gradually reduce the Hall tax. While we wait for the legislative process, investors must understand the tax.

Since the financial crisis hit in 2008, interest rates have been historically low. Savers have faced insultingly low interest rates on their bank accounts. Bond investors who historically bought high-quality bonds with yields of 5 or 6 percent have seen those bonds mature only to find new bonds being issued with 2 or 3 percent yields or less. This has created a difficult situation for many, especially retirees, who depend on bonds to provide sufficient interest to support their standard of living.

Many investors have moved their assets out of certificates of deposit and into dividend stocks for the higher yield, but they unknowingly have moved from a non-taxable interest item to a taxable interest item, according to the state of Tennessee. These investment changes can create a tax liability for Tennessee residents.

Have you changed your portfolio to increase yield and earnings? If so, talk to your tax preparer about the impact these changes may have on your total tax bill.

Phoebe Venable, chartered financial analyst, is president and COO of CapWealth Advisors LLC. Her column on women, families and building wealth appears each Saturday in The Tennessean.