Year-End Tax Planning Tips

You may be able to reduce your tax liability if you consider adopting these tax strategies before year’s end.

Few words can dampen the cheer and optimism of a New Year like taxes. Let’s face it, the time for holidays, time off, and family should be celebratory, not burdensome. But if you approach taxes with an eye toward reducing your liability for next year, the concept becomes more amenable. And indeed, there are numerous tax-savings strategies that you can implement that could potentially reduce your tax obligations. Let’s take a look.

Turn Losses into Gains

If you anticipate that your investments will yield short- or long-term capital gains, you can offset these with realized capital losses, according to the IRS.

For assets that you hold less than a year, the gains (short-term) are taxed at ordinary rates from 10% to 37%, which you can offset with short-term losses. Similarly, for assets that you hold longer than a year (long-term), the gains are taxed at a top rate of 20%, which you can reduce by long-term capital losses.(1) If your losses exceed your gains, you can deduct up to $3,000 in capital losses against your ordinary income on that year’s tax return, while carrying forward unused losses, if any, to future years.

Accordingly, you might consider avoiding short-term gains, since these are taxed at higher rates. If you are anticipating a short-term gain, either offset them with short-term losses, or else consider holding onto the assets for at least a year, when they become long-term assets.

Review your portfolio and estimate your gains and losses. Most capital gains and losses are triggered when you sell the asset, offering you control over the event. However, others — mutual funds, for instance — are difficult to predict as they are comprised of numerous assets. Assess those assets that have performed well and those that have incurred losses. If there are under-performers that can cover your gains, it will help minimize your capital gains tax.

Also, it is advantageous to elect losses before gains, as you can carry over unused losses to future years. Capital gains are taxed in the year in which they are realized.

Avoid the Net Investment Income Tax

The IRS assesses a 3.8% tax on unearned income for high-income taxpayers, which applies to single taxpayers with a modified adjusted gross income of $200,000 or more and for those who are married and filing jointly with a modified adjusted gross income of $250,000 or more. This increases the top rate on most long-term capital gains to 23.8%, which applies to interest, dividends, royalties, and rents, among other items (collectively called “net investment income”).

(1) According to IRS Publication 550, Investment Income and Expenses, you can offset long-term gains with net short-term capital losses, too, in certain instances. See https://www.irs.gov/forms-pubs/about-publication-550.

Assets that do not fall under this net investment income classification and thereby avoid the 3.8% additional tax include distributions from IRAs or qualified retirement plans, annuity payouts, and income from tax-exempt municipal bonds. Consider these distinctions to avoid additional tax liability.