A lot of people believe that all they need to do for retirement is defer as much money as possible. They assume that when they retire, they’ll be in a lower tax bracket and can start withdrawing money for spending purposes. This is frequently not the case, and for various reasons, it’s looking even less likely for the future.
Research shows that tax-efficient financial planning can deliver several years of additional portfolio longevity and improve estate plan efficiency.1 Tax planning is the practice of analyzing an investment strategy to ensure all elements work together to minimize income taxes. A plan that minimizes income taxes is referred to as “tax efficient.” Designing a successful retirement depends on tax efficiency, as well as maximizing the ability to contribute to Roth IRA and 401(k) plans.
How much do you know about the tax implications of investing? Most people can only correctly answer half of the questions in this 10-question quiz. Can you beat the average? Let’s find out!
- Which of the following IRS forms are used to report information about capital gains and losses?
- Form 1040
- Form W‑2
- Form 2439
- Schedule D
- What are the three types of capital losses?
- Realized losses, unrealized losses, and recognizable losses
- Realized losses, potential losses, and recognizable losses
- Recognizable losses, long-term losses, and short-term losses
- When a taxpayer acquires property as a gift, the general rule is that they take the donor’s basis in the property. (The basis is your capital investment in an asset for tax purposes—typically what it cost you, or your profit or loss when you sell it.)
- True
- False
- Which changes were made as part of the American Taxpayer Relief Act (ATRA) of 2012?
- The ATRA eliminated capital gains rates for taxpayers not in the highest income bracket.
- The ATRA significantly lowered taxpayers’ tiered capital gains rates across income brackets.
- The ATRA extended the 0% and 15% capital gains rates for most taxpayers and increased the rates for taxpayers in the highest income tax bracket to 20%.
- How did the Tax Cuts and Jobs Act of 2017 affect the specific tax rates for long-term capital gains and qualified dividend income?
- The 2017 tax reform law retained the prior tax rates that apply to long-term capital gains and qualified dividend income.
- The 2017 tax reform law halved the tax rates for long-term capital gains and qualified dividend income.
- The 2017 tax reform law eliminated the taxes that apply to long-term capital gains and qualified dividend income.
- The amount of capital losses a taxpayer may deduct against other income in a tax year is limited to $3,000 for single filers and $6,000 for those married filing jointly.
- True
- False
- Short-term capital gains enjoy the same preferential capital gains rates as long-term gains.
- True
- False
- If a taxpayer acquires property from a deceased person by inheritance or bequest, how is their basis in the property determined?
- The basis is determined to be the property’s fair market value as of the beginning of the taxable year in which the original owner died.
- The basis is determined to be the same as that of the original owner.
- The basis is determined to be the property’s fair market value as of the original owner’s date of death.
- When a loss is realized on a sale between related persons, how is the loss treated for tax purposes?
- Such a loss is disallowed and may not be used to offset capital gains for income tax purposes.
- The loss is allowed only so long as the transfer resulted from a bona fide “arm’s‑length transaction” (where the buyer and seller acted independently without influencing each other).
- The loss is allowed only so long as an unrelated middleman conducts the transfer.
- Which of the following types of property are generally not considered to be capital assets?
- Investment portfolios holding only cash or cash-like instruments.
- Supplies that are regularly used or consumed by the taxpayer in the ordinary course of their trade or business.
- Individual bonds issued by the federal government.
***
So, how did you do? Were you surprised by any of the questions—or answers?
If you missed a question, you’re in good company. Few people have a comprehensive knowledge of tax planning.
It’s a particularly challenging subject because tax laws often change year over year. Even if Congress doesn’t pass a new law, some tax laws might be expiring while others are scheduled to change automatically.
At Rodgers & Associates, we’ve mastered the details of tax-efficient retirement planning so our clients can consider the big picture. Our proprietary strategy—called the New Three-Legged Stool™—is a way to both minimize income taxes every year and save taxes in the long term, all while providing flexibility with retirement savings. It sets the basis for a plan we can adapt and tweak with our clients annually.
Thanks for taking the test and turn to the footnotes if you’re interested to learn more.
Answers:
- a. & d.2
- a.3
- True.4
- c.5
- a.6
- False.7
- False.8
- c.9
- a.10
- b.11
Footnotes
- Seeking Tax Alpha in Retirement Income. By James DiLellio and Andreas Simon, Graziadio Business School, Pepperdine University, November 2022.
- Capital gains and deductible capital losses are reported on Form 1040, Schedule D, and then transferred to line 13 of Form 1040, U.S. Individual Income Tax Return. Capital gains and losses are classified as long-term or short-term. If an investor holds the asset for over a year, their capital gain or loss is long-term. The capital gain or loss is short-term if they hold the asset for one year or less.
- Capital losses can be used as deductions on the investor’s tax return, just as capital gains must be reported as income. Unlike capital gains, though, capital losses can be divided into three categories. Realized losses occur on the actual sale of the asset or investment. Unrealized losses, for their part, are not reported. Finally, recognizable losses are the amount of a loss that can be declared in a given year.
- Concerning a gift of property, the general rule is that the donee taxpayer takes the donor’s basis in the property. The exception to this general rule is triggered if, at the time of the gift, the donor’s basis is greater than the fair market value of the gifted property. In that case, the donee taxpayer’s basis is the property’s fair market value.
- The American Taxpayer Relief Act of 2012 extended the 0% and 15% capital gains rates for most taxpayers and increased the rates for taxpayers in the highest income tax bracket to 20%. Under this framework, the applicable threshold amounts are adjusted annually for inflation.
- The 2017 tax reform law retained the current tax rates that apply to long-term capital gains and qualified dividend income. However, the income thresholds that determine to whom those rates will apply did change, moving in tandem with the TCJA’s updates to the individual income tax rates.
- A non-corporate taxpayer who has capital losses in excess of capital gains is entitled to deduct from ordinary income the lesser of (a) $3,000 ($1,500 for married taxpayers filing separately) or (b) the excess of the taxpayer’s net capital losses over gains. Any nondeductible losses may be carried forward indefinitely to subsequent tax years. Losses carried forward retain their character as either short-term or long-term in future years.
- Net short-term capital gain is not subject to the preferential capital gains rates. Instead, such gain is taxed as ordinary income (up to 37%). The complex rules applicable to capital gains taxation establish four types of capital assets. These groups of capital assets are short-term capital assets, with no special tax rate: 28% capital assets, generally consisting of collectibles gain or loss, and IRC Section 1202 gain; 25% capital assets, consisting of assets that generate unrecaptured IRC Section 1250 gain; and all other long-term capital assets, which are taxed according to the taxpayer’s taxable income.
- The basis is determined to be the property’s fair market value as of the original owner’s date of death. Generally speaking, “tax basis” is a taxpayer’s after-tax investment in property. In other words, when a taxpayer acquires property for money, the purchase price is presumed to be their after-tax investment in such property. When the property is sold or exchanged for computing gain, the difference between the amount received and the taxpayer’s basis in the property is the taxable gain.
- Such a loss is disallowed and may not be used to offset capital gains for income tax. If an individual sells property at a loss to a related person, that loss is disallowed and may not be used to offset capital gains for income tax purposes. It makes no difference that the sale was a bona fide arms-length transaction, nor does it matter that the sale was made indirectly through an unrelated middleman. The loss on the stock sale will be disallowed even though the sale and purchase are made separately on a stock exchange and the stock certificates received are not the certificates sold.
- Supplies that are regularly used or consumed by the taxpayer in the ordinary course of the taxpayer’s trade or business. Generally, any property held as an investment is a capital asset, except that rental real estate is typically not a capital asset because it is treated as a trade or business asset. The Internal Revenue Code defines a “capital asset” by exclusion. Beyond consumable trade supplies, other types of excluded property include inventory held primarily for sale to customers; accounts or notes receivable acquired in the taxpayer’s trade or business for services rendered; and any commodities derivative financial instrument held by a commodities derivatives dealer.
