If you own Medtronic stock that has appreciated in value, the recent merger with Irish medical device firm, Covidien, may be a taxable event for you.
Normally, when one company buys or merges with another, it is not a taxable event for the acquiring company. Not in this case. The gains on Medtronic stock, which has appreciated more than 86% over the past 5 years, will be taxable when the deal closes later this year or early 2015.
According to information put out by Medtronic, this will apply to anyone who is a shareholder, not just Medtronic employees.
If you own Medtronic in your IRA, Roth IRA, 401(k) or other qualified account, don’t worry. Those shares aren’t taxable. However, if you own Medtronic stock in a taxable brokerage account or have individual shares in certificate form, you may be paying a higher tax bill in April.
The only people who will pay tax on their Medtronic shares are those who own them in taxable brokerage accounts or who own shares in certificate form. Medtronic shares owned in IRAs, Roth IRAs, 401(k) accounts and other qualified accounts, will not pay tax until they actually make a taxable distribution from those accounts.
Below is a brief summary of how the chips may fall based on your income:
• No tax. If your taxable income is low enough, you may not have to pay any tax. If you are a single tax payer with taxable income in 2014 that is less than $39,600, capital gains are taxed at 0%. Likewise, if you are a married taxpayer who files jointly with your spouse and your taxable income is below $73,800.
• Some tax. More likely you will pay capital gains at a rate of 15%. The majority of taxpayers fall into tax brackets in which capital gains are taxed at 15%. For married taxpayers filing jointly with taxable income between $73,801 and $457,600, you will pay a 15% capital gains tax on your Medtronic profits.
• Maximum tax. Some will pay tax at the highest rate. If your taxable income exceeds $457,600, you will pay capital gains at the top rate of 20%.
But wait, there’s more…
If your income exceeds $200,000 for a single person or $250,000 for married taxpayers, you may also be subject to an additional 3.8% surtax on top of the capital gains taxes mentioned above. If your income exceeds the above threshold amounts, your capital gains tax rate could be as high as 23.8%.
How the math works
You only pay tax (if you pay tax at all) on your gains on the Medtronic shares you own in taxable accounts. So, if you bought MDT at $51 in your brokerage account and it trades at $65 on the date of the Covidien close your taxable gain is $14 per share. For most taxpayers, 15% of that $14 or $2.10 per share is what you will owe the IRS. If you are in the highest tax brackets your capital gains tax could be up to 23.8% of your capital gain or $3.33 per share in the above example.
To minimize the impact of capital gains tax on your portfolio here is what you need to do before the Medtronic-Covidien deal closes:
First, get an accurate projection on what you expect your taxable income to be in 2014. The key is taxable income. This is the number found on line 43 of your 1040. If your income is below the thresholds described above for the 15% tax brackets, you don’t have to do anything. Your capital gains will not be taxed. If it’s higher, you may need to take some additional steps.
Second, if possible, take steps to lower your taxable income. If you can reduce your tax bracket, that could reduce or even eliminate your tax bill. How do you lower your taxable income? There are a number of ways, but they all fall into one of two categories: Defer income to another tax year, or accelerating your tax deductions in the current tax year.
Deferring income might mean decreasing your IRA or 401(k) distributions if you are retired, delaying the exercise of stock options, or taking other steps postpone your income until a future tax year.
Accelerating your deductions could include increasing your charitable contributions (maybe you give more in 2014 and less in 2015 shifting the tax benefit to a year in which you may need it more), increasing your 401(k) or other retirement plan contributions, or even contributing to a tax deductible IRA.
Third, consider selling taxable investments that have suffered losses. If you own stock that is worth less than you paid for it, those capital losses can be used to offset capital gains on other investments. In fact, if you have experienced losses in past tax years and have a tax-loss carry forward that will also offset some or all of your 2014 capital gains.
Fourth, be extra mindful of tax efficiency in your taxable investment accounts. Tax efficiency is always important, but now even more so. Taking losses on poor investments, avoiding investments that may distribute taxable gains, and seeking out investments that trade less frequently are all strategies that can help to lessen the pain at tax time. While this strategy may not reduce your tax bill from the Medtronic deal, improving your tax efficiency will at least keep it from being worse than it needs to be.
Fifth, donate your stock to charity. And do it before the Medtronic-Covidien deal closes. When you donate highly appreciated assets like shares of stock, you not only get to deduct the value of the stock from your taxable income, but you also avoid the capital gains tax on those shares. Let me give you an extreme example.
If you bought Medtronic stock in 1985, you might have paid about $1 or less for each share. At today’s prices those shares are now worth $64 each. That’s a gain of $63. When you give that share of stock to your favorite charity, you avoid the capital gains tax and get to write off $64 per share from your taxable income.
If your donation is relatively small, you may just want to include it as part of your charitable contributions for the year. The only difference is that this year you might give stock to your church or favorite charity rather than simply writing them a check in December.
If your donation is more sizable, you may want to consider the use of a charitable trust or donor-advised fund. Charitable trusts and donor-advised funds allow you to receive income from your gift during your lifetime. When you die, the balance or remainder passes to the charity you chose as trust beneficiary.
Consider all your options before taking action
This is not a one-size-fits-all situation. Be sure to consider all your options carefully and discuss any tax strategies with your financial advisor and tax professional before taking action. What is right for your neighbor, may not be right for you.
If you are a long-time Medtronic shareholder, you are probably going to have to pay taxes on your gains in April. You can’t control that, but you might be able to control the amount of tax you pay by taking some proactive steps now.