Benjamin Franklin once said, “In this world, nothing can be said to be certain, except death… and taxes.” He was absolutely right. No matter where you live on the globe, there will always be taxes on something, and paying taxes on investment earnings is something that takes place in every part of the globe.
As citizens or residents of the United States, paying taxes is something all of us have to do every year as individuals, or jointly if filing with a spouse. But even though we all pay taxes, it doesn’t mean we can’t legally make tweaks to minimize what we owe. There are many wealthy people today who can legally minimize their tax owing every year. All they do learn their tax laws and prepare for tax season.
As taxpayers, it should be expected that everyone conducts proper tax planning so that we can preserve our assets as much as possible.
Doing this is a challenge for most people though. Most people need something quick and simple to follow so that they can have an easier time preparing for tax season. Or they will simply have someone else do it for them. If you’re someone that cannot afford to have someone do it for you, you are probably looking for some quick and easy solutions to maximize the preservation of your assets, and minimize your tax liability.
If you are an active participant in buying stocks, bonds, and mutual funds, read on. In this article, I will be going over 5 simple tax strategies that you can follow to keep as much of your assets as possible.
#1 Review Your Gains & Losses
From January 1st to December 31st of every year, there will be multiple investment transactions that will have tax implications. As an investor, you need to be aware of which transactions can cause implications and which don’t.
To do this, and to ensure that you have paid off enough estimated taxes to cover any short-term capital gains or even long-term, you must review your gains and losses for the given year. Keep note of all the transactions that took place and which of your gains and losses were realized throughout the year.
A year-end review can help you plan for the potential of the Alternative Minimum Tax (AMT) as large capital gains can trigger AMT liability.
What is AMT liability? It applies to taxpayers with high economic income, it sets a limit on benefits that significantly reduce a taxpayer’s regular tax amount. It helps to ensure that those taxpayers pay at least a minimum amount of taxes on their assets.
#2 Sell at a Lower Marginal Tax Rate
An investment that increases in value while paying no income to you (such as dividends) is not taxed until it has been sold. Some dividend-paying assets are taxed as regular income every year, even if you haven’t sold your investment.
If the value of your investment is going up, you should practice patience… a lot. It would be ideal for you to wait to sell it until the year at which your marginal tax rate is lower than what it currently is. For most people, this is retirement. Since they are no longer receiving regular earned income, their marginal tax rate could definitely be lower!
If you are expecting to have a lower marginal tax rate at retirement, do everything you can to hold off selling your investments until then.
#3 Offset your Gains with your Losses
If you cashed in a significant amount of gains during the year, review your portfolio for any unrealized losses. Once you find these losses, analyze their price and intrinsic value to determine whether that investment is likely to rebound or crash.
If your investment has a low possibility of rebounding and thus crashing, sell it! Use the losses of those assets to offset the gains you’ve made during the year. If you take part in capital gains harvesting (which will be discussed in further detail in the next section of this article), you can also use your losses to offset your gains.
More than likely though, you won’t be as eager to do it, as capital gains harvesting saves you a lot of money on taxes. This leads me to the next point.
#4 Long-Term Capital Gains
You have probably seen “long-term capital gains” so many times throughout this website. This is only because it is so effective at saving people a lot of money in taxes.
Remember that term, “capital gains harvesting”? It is the process of turning unrealized long-term capital gains into realized capital gains at a specific time for tax purposes. When you buy and hold an investment for at least 1 year and 1 day, you can take advantage of long-term capital gains tax treatment on your returns.
There are two types of capital gains taxes. There are short-term capital gains and long-term capital gains.
Short-term capital gains are profits you make from selling an investment before a 12-month period. They are taxed at your regular marginal tax rate for the given year.
Long-term capital gains are profits you make from selling an investment after a 12-month period. These are taxed much more favorably and are only taxed at a 0%, 15%, or 20% rate. The rate depends on your earned income.
The tax rates for long-term capital gains are as follows for the year 2020:
- 0% – $0 to $40,000 income
- 15% – $40,001 to $441,450 income
- 20% – $441,451 or more income
When you wait to sell your investments until they qualify as long-term capital gains, you maximize the savings on those gains. And you will only be taxed at one of the three rates listed above.
#5 Look for the Right Investments
Most investors are passive in their investing practices. They have many things going on in their lives and don’t have time to conduct all the fundamental analysis that is necessary to pick their own stocks and build their own investment portfolio.
Passive investors like to invest by using vehicles like index funds or mutual funds. If you’re specifically looking for a vehicle that is professionally managed by licensed professionals, you want to invest using mutual funds.
Although you have no control over the timing of sales within the mutual fund you choose, you can still choose the right mutual fund that gives you the most advantages. Look for mutual funds that potentially consider certain tax advantages and savings strategies.
Although you may be a passive investor, there still needs to be some level of work on your part if you want to make the right choices on what you put your hard-earned money into. It won’t be as much work as an active or enterprising investor, but it required work that you can’t get around. Don’t worry, it will pay off for you in the long-run.
Investing is a fun but risky game. You are putting your hard-earned money into something that should be going up in value, but it isn’t guaranteed. Nonetheless, if you make the right decisions, your investments will surely be going up.
But just because the value of your investment is climbing, it doesn’t mean that all that money will be yours in one go. Taxes will take a big bite of those gains, but you have the power to strategize accordingly and minimize what Uncle Sam can take from you.
You’re growing your assets, make sure to keep as much of them as possible. Don’t let taxes take more than they should from you. You have great examples like Warren Buffett who prove that with the right strategies, you can keep the largest sums of your hard-earned money all to yourself.
If you’ve made it to the end of this article, leave a comment below, and let me know how implementing these five tips has helped you this tax year.