One of the most effective ways to avoid tax time surprises is to play your tax strategy throughout the year. This includes your investment tax strategy. Remember that investment income is often taxed differently than other income, so it makes sense to include that in your strategy for the coming year. Here are some things to keep in mind:
Long-Term vs. Short-Term Capital Gains
First of all, you need to understand the difference between long-term capital gains and short-term capital gains. If you hold an investment for a year or less, it’s considered short-term, and will be taxed as ordinary income. If, however, you hold an investment for 366 days, you can consider it a long-term gain, and receive favorable treatment. The long-term capital gains rate tops out at 20 percent if you are in the top marginal tax bracket; that’s better than paying 39.6 percent on that income.
If you decide to sell assets at a gain this year, do your best to sell long-term assets so that you end up with a more favorable tax rate (and realize that collectibles and some small business stock is a flat 28 percent rate, no matter how long you’ve held the asset).
Offsetting Gains with Losses
You can also offset your gains with losses. If you want to sell a losing stock, consider how you can match it up with the gains you receive from selling a winner. You start by matching short-term losses with short-term gains and long-term losses with long-term gains. Any remaining losses can offset other gains. In fact, you can use losses to offset your regular income up to $3,000 as well, if you manage to overcome all of your gains. You can even carry forward your excess beyond that threshold to future years.
If you plan to restructure your portfolio this year, keep all of this in mind so that you can plan accordingly.
Reducing Your Income
During the most recent tax filing season, many couples were surprised by higher taxes, due to the Additional Medicare Tax and the Net Investment Income Tax which were introduced for tax year 2013. If you are married filing jointly and you make more than $250,000, you are subject to an additional tax of 0.9 percent for Medicare, and your investment income is subject to an extra 3.8 percent.
If you want to avoid these issues next year, you can plan ahead so that your income is lower. Check for deductions that you are eligible for, and look for ways to reduce your income, either by shifting some of it to a future year, or by using the right deductions to keep you below the threshold. You might want to consult with a tax and/or accounting professional to help you figure out how to make this happen. In some cases, if your income is much higher than the threshold, there’s not a lot you can do other than just work to reduce the taxable income as possible.
With a little tax planning now, you can reduce your stress later, and reduce the impact of your investment income on your tax liability.