Year-Round Tax Planning Strategies - Rodgers & Associates
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Year-Round Tax Planning Strategies

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No one wants to think about tax planning after April 15. However, if your goal is to minimize incomes taxes, tax planning should be a year-round activity. This is especially true for investors. Tax impli­ca­tions should not be the driving factor when making investment decisions, but they should be part of the process. Many tax rules and regula­tions impact invest­ments, and it is easy for investors to become overwhelmed. This is where your tax accountant and financial adviser need to collab­orate to structure an investment strategy and tax strategy that work together.

Here are some essential investment decisions that can have signif­icant tax implications:

Allocation among accounts
Investors should consider using the New Three-Legged Stool™ approach to savings, allocating funds to taxable, tax-deferred, and tax-free (Roth) accounts. The most tax-efficient invest­ments, such as municipal bonds, non-dividend paying stocks, and growth-oriented passive mutual funds and ETFs, should usually be held in a taxable account. The least tax-efficient investments—such as corporate bonds, real estate investment trusts, and income-oriented mutual funds—might serve you better in a tax deferred account.

Master limited partner­ships (MLP)
MLPs are popular in low-interest-rate environ­ments because they must distribute 85% of their income. Many MLPs generate unrelated business income, and these invest­ments usually belong in a taxable account even though they are income oriented. If held in a tax-deferred account, they may produce unrelated business taxable income (UBTI). When UBTI is greater than $1,000, the investor must complete and file Form 990 and pay additional income tax.

Gold and other collectibles
The IRS catego­rizes gold and other precious metals as collectibles rather than invest­ments. Collectibles are not eligible for capital gains treatment, which has a maximum tax rate of 20% for taxpayers in the top tax bracket. The federal tax for long-term gains on collectibles is 28%. This same rule applies to exchange traded funds (ETFs) backed by physical gold, and the gain on your gold ETF may be taxed as a gain on a collectible.

Cryptocur­rencies
The IRS classifies cryptocur­rency as property, and cryptocur­rency trans­ac­tions are taxable. Taxes are due when you sell, trade, or dispose of cryptocur­rency in any way for a gain. Trades between cryptos are also considered taxable events. If you trade one cryptocur­rency for another, it is reportable in U.S. dollars on your tax return.

Just like stocks, cryptos are taxed as either long-term or short-term capital gains depending on the holding period. Losses in cryptos can be taken against other capital gains but are capped at $3,000 against other income.

Foreign stocks and stock funds:
Line 7 of Form 1099-DIV shows the amount of foreign taxes withheld on dividends paid. U.S. taxpayers get to recoup this tax withholding in a tax credit on their tax returns. The credit is only available when the foreign stocks are held in a taxable account.

Holding periods for capital gains
Realized gains on appre­ciated securities held for one year or more qualify for favorable tax treatment. Long-term capital gain tax rates are signif­i­cantly lower for taxpayers, and the tax rate is zero for taxpayers in the 12% tax bracket. Short-term capital gains are considered ordinary income and taxed at a higher rate. So, before selling a security, be sure to check when it was purchased. Delaying the sale could result in consid­erable tax savings.

Combine chari­table inten­tions with investment management
Before selling a security with a capital gain, consider using it instead to fulfill philan­thropic goals. Donating appre­ciated assets makes the most sense when a taxpayer has a long-term capital gain asset with a low adjusted tax basis. The donor deducts the current appre­ciated value of the asset as a chari­table gift and avoids the capital gain tax incurred if the asset were sold. It is often better to give appre­ciated assets than cash.

Roth conver­sions for long-term savings
When a tradi­tional IRA is converted to a Roth IRA, tax is due on the converted amount in the year of conversion. Consider Roth conver­sions in tax years when you have low income from other taxable sources. Partial conver­sions can sometimes maximize tax savings. Over time, well-planned Roth conver­sions will minimize required minimum distri­b­u­tions at age 72 and provide a tax-free source of funds when needed for large purchases.

Harvest capital gains in low-income years
Anyone in the 12% tax bracket should consider realizing long-term capital gains up to the top of their tax bracket. For 2022, the top of the 12% tax bracket is $41,775 for single taxpayers and $83,550 for married filing jointly. After deduc­tions, this is taxable income, and long-term gains are taxed at zero in this tax bracket. Taxpayers who live in states that tax capital gains will want to consider their individual state’s tax treatment before imple­menting this strategy.

Making investment decisions is compli­cated on its own but adding the complexity of tax impli­ca­tions can make it feel daunting. But with the top marginal tax rate now at 37%—and the Medicare surtax on investment income adding another 3.8%—tax efficiency is more important than ever.

Rick’s Tips:

  • The New Three-Legged Stool approach to savings provides oppor­tu­nities to create tax efficiencies by allocating invest­ments over the three legs.
  • MLPs may appear to be more tax-efficient in an IRA, but if they produce UBTI, they should be held in a taxable account.
  • Roth conver­sions can be an essential part of a long-term tax strategy.

Origi­nally Posted: April 24th, 2014