Tax Planning Moves for Investors

Investing is all about growing your money within safe limits and at a pace that will allow you to reach all your retirement and savings goals. While returns are a function of the financial markets, they are also impacted by taxation.

investing tax planning moves

Let’s work through a few tax moves you should consider to be more tax efficient:

  1. Move to ETFs – Exchange-traded funds utilize a gap in the tax code that allows them to pass on little to no tax liability to their investors. Exchange-traded funds never buy or sell stocks, instead they swap them in in-kind exchanges that do not create a tax liability. Mutual funds, however, have to buy and sell stocks. If your favorite mutual fund is available as an ETF, consider making the move to lighten your annual capital gains tax bill.
  2. Invest for charity – Selling a winning stock to make a donation to your favorite charity is one of the worst tax moves to make. When making a charitable donation, consider donating an investment directly without cashing it in. Donating the investment means you’ll avoid selling, and thus avoid the capital gains tax due on the investment that you made.
  3. Contribute more to an IRA – Did you miss the boat on making more contributions to your IRA last year? There’s no reason to worry; you can contribute to an IRA for the previous tax year all the way up to the day taxes are due in April for the previous year. If you haven’t yet maxed out, consider adding more to your retirement savings as once the deadline passes that headroom is gone forever – you can’t reclaim lost opportunity in maxing out your retirement accounts.
  4. Examine your cost basis – In 2013, the IRS will finish a new requirement for brokerage firms to automatically determine the tax basis for any stock, mutual funds, commodities, or bonds that you hold in your account. Check to see if your broker has a default setting – LIFO or FIFO – and turn it off. A blanket tax basis method is not tax efficient. You’ll want to choose which stocks or mutual funds you sell to get the lowest possible tax rate (long-term capital gains vs. income, for example).
  5. Put income investments goes to tax-advantaged accounts – Investments that generate ordinary income, not qualified dividends, like REITs, business development companies, bonds and bond funds, and MLPs should be kept in a tax-deferred account. Your tax rate on income will likely be lower at retirement than in your peak earnings years, and reducing income now will keep you far away from triggering the binary Medicare surtax on income in excess of new limits.
  6. Use any carryovers – If you have tax losses from years previous, be sure to match them by taking a gain in the next calendar year. There’s little reason to allow Uncle Sam to have more of your money than he should. Use those carryovers this year rather than next to collect on tax savings a year earlier.
  7. Cut losses and pair with gains – At any time you take a capital gain you can pair it with a capital loss to even out your tax liability. Consider doing so, but mind the wash sale rules which prohibit you from purchasing the same or similar security within 30 days of the sale of a losing investment.

Just as budgeting isn’t what you make, but what you keep, investing is the same way. Having a high-flying, rapidly appreciating investment portfolio means very little if too much goes to Uncle Sam. If you apply some of the tax moves above, you’ll make the biggest steps toward a 100% tax-efficient portfolio with little to no work on your part.

2 Responses to Tax Planning Moves for Investors

  1. Good post! I am always amazed to see how investors often do not take taxes into consideration when they’re doing their investing, when it really does play a big role. I think the cost basis changes the IRS has made is great and totally agree that a default setting at your brokerage should be turned off in most cases.

  2. STEVEN J. FROMM, ATTORNEY, LL.M. (TAXATION) says:

    Great post. As to your point about charitable contributions, in certain cases taxpayers may want to employ something called charitable remainder trusts. They come in two forms, one called a charitable remainder unitrust and the second called a charitable remainder annuity trust. They can be used for charitably minded taxpayers who want to diversify their portfolio and reserve the income to themselves or others and pass the remainder to charity. They also get an income tax deduction for the value of the remainder that passes to charity.

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