Financial Focus : Income Tax Planning, Chapter 4 – Investing & Taxes


No easy task: Tax planning for investments involves many considerations

When it comes to tax planning and your investments, it can be difficult to know where to start. First, tax treatment of investments varies based on a number of factors. You need to understand the potential tax consequences of buying, holding and selling a particular investment. Higher-income taxpayers also need to know when higher capital gains tax rates and the ACA’s net investment income tax (NIIT) kick in. Yet, it’s unwise to make investment decisions based solely on tax consequences — you should consider your risk tolerance and desired return as well. Finally, your portfolio and your resulting tax picture can change quickly because of market volatility. Vigilance is necessary to achieve both your tax and investment goals.

Capital gains tax and timing
Although time, not timing, is generally the key to long-term investment success, timing can have a dramatic impact on the tax consequences of investment activities. Your long-term capital gains rate might be as much as 20 percentage points lower than your ordinary-income rate. The long-term gains rate applies to invest- ments held for more than 12 months. The applicable rate depends on your income level and the type of asset. (See Chart 2.)

Holding on to an investment until you’ve owned it more than a year may help substantially cut tax on any gain. Here are some other tax-saving strategies related to timing:
Use unrealized losses to absorb gains. To determine capital gains tax liability, realized capital gains are netted against any realized capital losses. If you’ve cashed in some big gains during the year and want to reduce your 2014 tax liability, before year end look for unrealized losses in your portfolio and consider selling them to offset your gains.

Avoid wash sales.
If you want to achieve a tax loss with minimal changein your portfolio’s asset allocation, keepin mind the wash sale rule.It prevents you from taking a loss on a security ifyou buy a substantially identical security (or an option to buy such a security) within 30 days before or after you sell the security that created the loss. You can recognize the loss only when you sell the replacement security.

Fortunately, there are ways to avoid triggering the wash sale rule and still achieve your goals. For example, you can immediately buy securities of a different company in the same industry or shares in a mutual fund that holds securities much like the ones you sold. Or, you may wait 31 days to repurchase the same security. Alternatively, before selling the security, you can purchase additional shares of that security equal to the num- ber you want to sell at a loss, and then wait 31 days to sell the original portion.

Avoiding or reducing a 3.8% NIIT hit

When Charlie and Julia fled their 2013 joint tax return, they were surprised to be hit with a new tax on their investments: the NIIT. Under the ACA, starting in 2013, taxpayers with modified adjusted gross income (MAGI) over $200,000 per year ($250,000 for married fling jointly and $125,000 for married fling separately) are subject to this extra 3.8% tax on the lesser of their net investment income or the amount by which their MAGI exceeds the applicable threshold.
To learn how they might reduce their NIIT hit in 2014 (or perhaps even avoid the tax), Charlie and Julia decided to consult a tax advisor. The advisor explained that many of the strategies that can help save or defer income tax on investments can also help avoid or defer NIIT liability. For example, they could use unrealized losses to absorb gains or transfer highly appreciated or income-producing assets to a family member who isn’t subject to the NIIT. And because the threshold for the NIIT is based on MAGI, strategies that reduce MAGI — such as making retirement plan contributions could also help avoid or reduce NIIT liability.

Swap your bonds.
With a bond swap, you sell a bond, take a loss and then immediately buy another bond of similar quality and duration from a different issuer. Generally, the wash sale rule doesn’t apply because the bonds aren’t considered substantially identical. Thus, you achieve a tax loss with virtually no change in economic position.

Mind your mutual funds.
Mutual funds with high turnover rates can create income that’s taxed at ordinary-income rates. Choosing funds that provide primarily long-term gains can save you more tax dollars because of the lower long-term rates.

See if a loved one qualifies for the 0% rate.
The 0% rate applies to long-term gain that would be taxed at 10% or 15% based on the taxpayer’s ordinary-income rate. If you have adult children in one of these tax brackets, consider transferring appreciated assets to them so they can enjoy the 0% rate. This strategy can be even more powerful if you’d be subject to the 3.8% NIIT or the 20% long-term capital gains rate if you sold the assets.

Warning: If the child will be under age 24 on Dec. 31, first make sure he or she won’t be subject to the “kiddie tax.” Also, consider any gift tax consequences.

Loss carryovers
If net losses exceed net gains, you can deduct only $3,000 ($1,500 for married taxpayers fling separately) of the net losses per year against ordinary income (such as wages, self-employment and business income, and interest).
You can carry forward excess losses indefinitely. Loss carryovers can be a powerful tax-saving tool in future years if you have a large investment portfolio, real estate holdings or a closely held business that might generate substantial future capital gains.
Be aware, however, that loss carryovers die with the taxpayer. So older or seriously ill taxpayers may want to sell investments at a gain now to absorb these losses.
They can immediately reinvest the pro- ceeds in the same stocks if they wish to maintain their position. The wash sale rule isn’t an issue because it applies only to losses, not to gains.
Alternatively, they can use the proceeds to purchase different stocks and diversify their portfolio at no tax cost.
Finally, remember that capital gains dis- tributions from mutual funds can also absorb capital losses.

Beyond gains and losses
With some types of investments, you’ll have more tax consequences to consider than just gains and losses:

*Dividend-producing investments.Qualified dividends are taxed at the favorable long-term capital gains tax rate rather than at your higher, ordinary-income tax rate. Warning: Qualified dividends are included in investment income under the 3.8% NIIT.

*Interest-producing investments.Interest income generally is taxed at ordinary-income rates. So, in terms of income investments, stocks that pay qualified dividends may be more attrac- tive tax-wise than, for example, CDs or money market accounts. But nontax issues must be considered as well, such as investment risk and diversification

*Bonds.These also produce interest income, but the tax treatment varies:

**Interest on U.S. government bonds is taxable on federal returns but generally exempt on state and local returns.
** Interest on state and local government bonds is excludable on federal returns. If the bonds were issued in your home state, interest also may be excludable on your state return.
** Tax-exempt interest from certain private-activity municipal bonds can trigger or increase the alternative minimum tax (AMT) in some situations.
** Corporate bond interest is fully taxable
for federal and state purposes.
** Bonds (except U.S. savings bonds) with original issue discount (OID) build up “interest” as they rise toward maturity. You’re generally considered to earn a portion of that interest annually — even though the bonds don’t pay this interest annually — and you must pay tax on it.

Stock options.
Before exercising (or postponing exercise of) options or selling stock purchased via an exercise, consult your tax advisor about the complicated rules that may trigger regular tax or AMT liability. He or she can help you plan accordingly.


What’s the maximum capital gains tax rate?
Assets held                                                                                2014

12 months or less (short term)                                  Taxpayer’s ordinary- income tax rate
More than 12 months (long term•                            

*39.6% ordinary-income tax bracket                                               20%
• 25%, 28%, 33% or 35% ordinary-income tax bracket                15%
• 10% or 15% ordinary-income tax bracket                                       0%

Some key exceptions
Long-term gain on collectibles, such as artwork and antiques 28%
Long-term gain attributable to certain recapture of prior
depreciation on real property                                                             25%

For the next several weeks, join us in educating you to the world of Tax Planning, 2014, but please , contact your tax advisor to learn exactly which strategies can benefit you the most.


Chapter 4 INVESTING (you are reading)
Chapter 5 BUSINESS
Chapter 8 TAX RATES


 Anthony Rivieccio is the founder & The CEO of The Financial Advisors Group, celebrating their 18th year as a fee only financial planning firm specializing in solving one’s financial problems. Anthony has been a recognized financial expert since 1986. He has been seen, heard or read by many national and local media outlets including: Klipingers Personal Finance Magazine, The New York Post, News12 The Bronx, Bloomberg News Radio, Bronxnet Channel 67 TV, The Norwood News, The West Side Manhattan Gazette, Labor Press Magazine, Financial Planning Magazine, WINS1010 Radio, The Bronx News newspaper and The Bronx Chronicle. Anthony can be reached at 347.575.5045



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