3 Simple Tax Tips to Use Now
Photo: Seth Anderson
With the tax deadline rapidly approaching, owing the least amount of money or getting the biggest refund possible is on the minds of many Americans.
However, for investors, tax time can be much more complicated and costly, if not planned for appropriately. Here are a few ways investors can help lessen their burdens this year, next year, and beyond.
Max out that IRA
IRAs are great because they allow investments to grow tax-free for years, which can tremendously help your returns over time. I recently wrote an article about this, but just as an example, consider that tax-free compounding can result in over 60% more in returns over a period of 30 years.
What a lot of taxpayers don't realize is they can still make contributions to their IRA accounts that will count for the 2013 tax year. If you are under the maximum contribution of $5,500, you have until the tax deadline to contribute. This will help lessen your future tax burden from your investments, but if your account is a traditional IRA, you have the added benefit of being able to deduct your contributions on this year's tax return, if you qualify.
Long term vs. short term
Beware of selling your winning positions too soon. The IRS defines a "long-term" capital gain as profits on an investment held for over one year. The difference in tax rates on long-term verses short-term holdings is substantial.
To illustrate this, let's consider an investor who is sitting on a $5,000 gain from a stock position that he's held for 10 months. If he sells now, his profits will be taxed as ordinary income, so if he's in the 28% tax bracket, that translates to a tax of $1,400. However, if he holds for another two months, the profits will be taxed at the long-term rate of 15%, or just $750, a savings of $650 just for holding on a little longer.
So, if you have a winning position you are considering selling that is a few months shy of the one-year mark, ask yourself if it is worth locking in those gains early at the expense of higher taxes.
About "tax loss selling"
On the other hand, if you are holding some losers in your portfolio, the end of the year may be a good time to do some house cleaning. Now, I'm not advocating dumping stocks you believe in over the long-term simply for their tax benefits. But if you are sitting on a losing stock you have been considering selling, the end of a tax year is a good time to pull the trigger.
The IRS allows investment losses to be counted against one's taxable income. So, if you're a buy-and-hold investor and your only sale this year was to sell your J.C. Penney stock, resulting in a $2,000 loss, your income can be adjusted by that amount. This can be very significant, especially if you are on the cusp of one tax bracket, or if you made just a little bit too much to qualify for a certain credit or deduction (the tuition credit, let's say).
So, why think about mainly year-end tax strategies in February? It's simple! Think about these things when making investment decisions in your portfolio. Maybe buy-and-hold is indeed the way to go. Maybe it's not so bad for your bottom line at the end of the year to cut losses in stocks you would normally hang onto.
Finally, the biggest tax benefit of all to investors, IRA investing, should be the priority at this time of year, and regular brokerage accounts should be used after maxing out your IRA.
By incorporating these three simple suggestions, you can take a serious bite out of your tax burden for years to come.
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