Year-end tax payments can be such an arduous task. No one enjoys hours and hours of computing their taxes and no one definitely wants to pay more than what’s necessary. Investors and traders should be especially careful of how they spend their money. There are already a lot of expenses out there and you should be smart about how to move your hard-earned money if you want to grow your wealth quicker.
Here are 4 effective year-end tax strategies to help minimize your tax liability.
1. Offset Losses
One of the main goals is to increase your long-term rate of return. A “good” rate of return will depend on several factors including the specific investment, inflation and the current market. Most investors would love 15% – 20% but this might not be possible, especially for those who are new to the game.
It is ideal to work on long-term return. To do this, it is critical to offset losses properly. Paper losses will not be beneficial in minimizing tax liability. Losing positions that were not realized must be sold to offset the gains that have been made earlier in the year. By the time capital gains increase, your booked losses will be more valuable.
2. Gift Appreciated Assets
A lot of investors donate to charities to reduce taxes but there’s another way to do this and that is by gifting appreciated assets. When you gift highly appreciated assets to someone from a low tax bracket, you can significantly reduce or even eliminate taxes entirely.
According to current tax laws, if you gift to someone in the 10% – 15% bracket, they would only have to pay 0% or 5% capital gains. However, this strategy is not applicable when gifting to children because of kiddie tax rules. By donating to a charity, you will avoid paying the incurred capital gain. Additionally, you also deduct the market value in full of the asset you donated.
Here’s an example – you buy Amazon stock at $10,000 and it grows into $15,000 in the next months. If you are in the 30% total tax bracket and you donate your stock position, you could actually save $5,000 – $1,500 in capital gain tax and $4,500 in ordinary income tax.
3. Identifying Securities Transactions
When you own several lots that have the same security and were bought/sold at different prices and times, identifying securities transactions is essential. Doing so will give a tax-planning opportunity. You can create the amount of loss or gain that will be recognized and also create long-term or short-term capital gain or loss.
On the other hand, if you don’t properly identify the lots that need to be sold, US treasury regulations will apply. This levies the first-in, first-out method of identification where the securities sold are the securities that you held onto for the longest.
4. Tax Loss Harvesting
If you are an investor that fall in high tax brackets, you should aim to offset short-term gains as much as you can. These types of gains are typically taxed at the investor’s tax bracket, which is in the 30% range. In contrast, long-term gains are taxed at the 0%, 15% and 20% range, depending on the income.
To get the final gain or loss result, short-term gains and losses are netted against each other. Afterwards, long-term gains and losses will also be netted. The results of these will be netted as well and you will get the final total. The difference in tax rates can be up to 24% for short-term (ST) or long-term (LT), so it is best to work on ending up with long-term gains. If it results in a loss, about $3,000 can be used to offset income.
There is an effective way to maintain the integrity of the asset class exposure while also avoiding the wash-sale rule. In this particular tax strategy, to take a loss in an asset class, you would have to sell a mutual fund and then deliberately replace it with the exchange-traded fund for a whole month. After 31 days, move the assets back.
Keep in mind that the best approach will depend on several factors including the taxpayer’s goals and their current state in life. There are several other tax strategies that you can try out to minimize liability. If you want the best results, it is advisable to work with a professional tax advisor who is experienced in building the ideal plan to save you money.