If you’re a committed investor, you are most probably counting on time to help you build the wealth to meet specific goals. And, since you have a long-term window in mind, you’ll want to follow these tips to help you be ready for tax time.
The Biggest Tax Concern for Investors?
The biggest source of concern for investors is around capital gains and how they may affect the taxes you pay.
Capital gains result when the sale of stocks and bonds generates a profit over what you paid initially. If you’ve owned the asset for less than a year, you will have a short-term gain that will be taxed as ordinary income.
When you own the asset longer than a year and a day, any gains or losses will be long-term and may be taxed at a lower rate.
And if you have losses from any sales, you may be able to use to offset short- and long-term gains with the equivalent losses.
As How to invest tax-efficiently explains,
“When your long-term gains exceed long-term losses on an asset you sell, you have a net long-term capital gain. Your “net capital gain” is the amount your net long-term capital gain for the year exceeds your net short-term capital loss for the year. Most taxpayers pay 15% or less on net capital gains. However, if your taxable income puts you in the highest ordinary tax bracket (37% for 2020) you’ll pay 20% on net capital gains.
For high-income earners, capital gains are also subject to a 3.8% net investment income tax. The NIIT affects taxpayers with modified adjusted gross income over $250,000 for a married couple filing jointly or $200,000 for single or head-of-household taxpayers.”
That said, don’t base all of your investment decisions on your taxes. Much better to develop a plan around meeting specific financial goals.
Here’s what we recommend that you consider doing so you can be prepared if not for the current year then for the future.
9 Tax Tips for Investors
1 – Invest Through Your Tax-Deferred Accounts
Make use of your tax-deferred accounts when you invest.
Tax-deferred accounts include traditional individual retirement accounts (IRA) and Roth IRAs and 401-K accounts. Earnings on your contributions can build over time tax-free. It’s when you withdraw the money that you pay taxes.
2 – Reinvest Dividends
Rather than receive cash dividends that are taxable, opt to have your dividends reinvested. You won’t be taxed until you sell the asset.
3 – Include Tax-Exempt Municipal Bonds in Your Portfolio
Have you considered tax-exempt bonds?
As Tax Tips for the Individual Investor recommends,
“Municipal bonds (aka munis) can also offer significant tax advantages. These bonds are often issued by state governments or local municipalities to finance a particular project, such as the construction of a school or a hospital or to meet specific operating expenses.
Most munis are issued with tax-exempt status, meaning the interest they generate does not need to be claimed when you file your tax return. Those that are highly rated, and thus low-risk, can be very attractive investments.“
And 15 Best Tax Tips for Investors further explains,
“As a rule of thumb, it benefits lower-income earners with lower tax obligations to invest in corporate bonds because of their higher returns. Higher-income earners are advised to buy muni bonds for their tax-exempt classification. There’s a simple formula for determining the so-called tax-equivalent yield, which will tell you which kind of bond is right for you. Find the tax-equivalent yield by dividing the tax-free muni bond yield by 1 minus your tax rate. Sound complicated? Don’t worry, many sites offer free and simple tax-equivalent yield calculators.”
4 – Claim Eligible Tax Deductions
Have you claimed eligible tax deductions related to your investments?
In addition to offsetting capital gains with capital losses, you can claim a capital loss deduction, as well as some investment expenses.
As Tax Tips for Investors details,
“When doing your taxes, make sure to claim eligible tax deductions for your investments. If you lost money on the sale of your investment in 2020, you can use the capital losses to offset your capital gains. If your capital losses exceed your capital gains in 2020, you’re allowed to claim a capital loss deduction of up to $3,000 per year ($1,500 if married filing separately). If you lost more than that, you can carry your losses over to future years…
If you itemize your deductions, you can deduct investment interest expenses against your net investment income. Investment interest can include margin interest from margin loans, which is money that you borrow against the value of mutual funds or stocks.“
5 – Make Use of Tax Incentives for Charitable Giving
Giving to charity offers opportunities to reduce taxes. For example, when you donate an appreciated stock instead of cash, you not only contribute a larger amount to the charity but you also receive a greater tax deduction.
You’ll find in How to invest tax-efficiently a compelling visualization of the comparison. The article further suggests that you,
“Contribute appreciated stock instead of cash: By donating long-term appreciated stocks, mutual funds, or cryptocurrency to a public charity, you are generally entitled to a fair market value (FMV) deduction, and you may even be able to eliminate capital gains taxes. Together, that may enable you to donate up to 23.8% more than if you had to pay capital gains taxes.3
Contribute real estate or privately held business interests (e.g., C-corp and S-corp shares; LLC and LP interests): Donating a non-publicly traded asset with unrealized long-term capital gains also gives you the opportunity to take an income-tax charitable deduction and eliminate capital gains taxes. Shares acquired through an employer stock program are generally good candidates for donation if held long-term and can reduce a concentrated position.
Accelerate your charitable giving in a high-income year with a donor-advised fund: You can offset the high tax rates of a high-income year by making charitable donations to a donor advised fund. If you plan on giving to charity for years to come, consider contributing multiple years of your charitable contributions in the high-income year. By doing so, you maximize your tax deduction when your income is high, and will then have money set aside to continue supporting charities for future years.“
6 – Don’t Be Tempted By ‘Wash Sales’
A ‘wash sale’ is the repurchase of an investment within thirty days after originally selling it at a loss. When that happens, the IRS will not allow you to claim the loss.
7 – Make Use of HSAs (Health Savings Account)
Health Savings Accounts allow you to contribute pre-tax money, and make tax-free withdrawals. Any distributions you don’t take for qualified medical expenses remain yours to use when you retire.
8 – Consider Paying Estimated Taxes
If you’re concerned about having to pay taxes on significant investment gains, consider paying quarterly estimated taxes.
9 – Evaluate Your Investment Strategy and Portfolio
Finally, regularly review your investment plan with your investment manager. Keep your long-term goals in mind so you don’t find yourself in a position where your worries about capital gains and taxes drive your investment strategy.
How Pendragon Capital Can Help You With Investing and Investor Tax Tips
Remember that investing carries risks, penalties, and tax implications so be sure to consult your investment and tax advisor beforehand. Pendragon’s approach is one of modern value investing and involves a touch of the contrarian.
If you need perspective investing – how to do it, why do it, when to do it – don’t hesitate to reach out to Pendragon Capital.
Thanks for reading.
Image credit: An Enquiry Concerning the Clock Tax, 1797 by Charles Ansell (English, active 1784-1796) after George Moutard Woodward (English, c. 1760-1809) published by S.W. Fores (English, 1761-1838). Art Institute of Chicago.
Note: This blog article is intended for general informational purposes only. Nothing in it should be construed as, and may not be used in connection with, an offer to sell, or a solicitation of an offer to buy or hold, an interest in any security or investment product. Investing involves risk.