It’s that time of the year again when U.S. citizens have to file their tax returns and pay their taxes. For the first time, taxpayers will also contend with changes in the law through the Tax Cuts and Jobs Act of 2017. Since the law, which amended the Internal Revenue Code of 1986, was passed in the late 2017, its effects and implications will be for the 2018 tax year, which will be filed this year.
When tax season comes, taxpayers scramble to get the most benefit from the tax refunds and tax credit provisions under the law. For individuals, the tax is pretty much cut and dry. It becomes more complicated with the individual have other entanglements like marriage, children and a business. Everybody wants to pay less. But with investors, there is always that mindset of wanting to spend as little money as possible while earning a lot. There are many strategies that could keep investor taxes at a minimum—legal strategies at that. Don’t even try doing an illegal maneuver or you will end up paying more than you should if caught. Or worse, you may even end up in jail.
If you are an investor and you want to keep tax at the barest minimum, you will want to get acquainted with the tax-loss harvesting strategy. This will also help you have increased long-term returns. Businessmen usually resort to this approach to taxes when their investments become less than the purchase price. But this strategy is a complicated matter because it has to be countered with other tax rules.
Here are some things you need to consider when figuring out how to minimize tax due:
Offset your capital gains
Based on the tax-loss harvesting strategy, a long-term capital loss could be used to cancel out a long-term capital gain. A long-term investment is assets including bonds, stocks, real estate and cash that a person holds or owns for more than a year. On the other hand, a short-term loss will be considered to offset a short-term capital gain. Those that will be considered as short-term investments are assets owned for less than a year. Excess loss from either short-term or long-term investment could be canceled out by either of the capital gains. Every year, there is about $3,000 in losses that could be applied to a person’s ordinary income. If there is an excess of loss from that, it could be rolled over in the next few years.
Better tax results from tax-loss selling
When an investment outperforms a particular index or the overall market, an alpha is created. Additional alpha could be conceived during tax-loss harvesting when a businessman is expected to have better tax results. One may be able to sell stocks or funds via losses. This will offset profitable sales from an earlier period.
When an investor sells or trades a security for a loss but then buys a similar stock or security within a month after the sale, a wash-sale occurs. Basically, the purchase washes out the sale that the person was forced to make. Take note of the use of the word “similar” because the Internal Revenue Service (IRS) frowns upon investors selling a security and buying an identical security within a month of the sale. In fact, frowns may be the wrong word as the IRS actually imposes a penalty on that. This is a means to prevent anyone from just making up losses in order to enjoy some tax benefits.
How tax-loss harvesting could minimize tax due
Businessmen don’t really need capital gains in order to take advantage of the tax-loss harvesting approach. As earlier mentioned, there is that rule that allows the offsetting of $3,000 in losses from ordinary income. Using that same amount, say an investor sells stock but via losses. That loss could then be utilized for the reduction of taxable income by $3,000. So let’s say a businessman loses a security but sells an asset to cover for the loss. He will then reduce taxable income worth $3,000 for the year and will then let additional losses roll over for the next few years.
On the other hand, this may also help create greater returns for the taxpayer. So if the businessman saves some amount in taxes every year by using the tax-loss harvesting scheme, he could use those savings and invest them in other forms of assets like in the stock market. Every year, the amount will see interest and would then increase to a hefty sum. In 25 years, your few hundred dollars of savings could already make tens of thousands of dollars.
There is a caveat though. Earning a hefty sum from tax-loss harvesting would only work for a certain range of income. Experts say tax-loss harvesting is not appropriate for an individual with less than $40,000 in taxable income as well as in a married couple with a joint taxable income of less than $80,000. Records indicate that for individuals making just around $38,600 a year and $77,200 for spouses filing jointly, the capital gains rate is zero.
Another thing, tax-loss harvesting is not applicable to the 401 (k) or the individual retirement account or other retirement accounts because losses from these accounts cannot be deducted.
Analyse first before selling stocks
There is a danger when an investor is only looking at the immediate solution and singling out the tax-loss harvesting strategy as an easy way out. There is a tendency that you sell a stock but within the month, the security rebounds. So always give yourself time to analyze stocks and funds and other related assets. Keep up with earnings calendar or the official public announcement of a company’s profitability over a time period. Never sell around earnings releases because profit reports from every company will immensely affect prices of assets. Give yourself time to analyze the market after earnings releases. Discuss your intention to sell with an expert over coffee. Some experts will definitely welcome the discussion without you wondering if you have to pay for that expert opinion.
This is one way to hide your money from tax in a very legal way. Very is put there for emphasis because a municipal bond is a debt obligation issued by a government. You basically put in money for the government to roll. Basically, you are allowing the government to loan some money from you. In return, your bond will earn interest. But the best part is, the amount you put in will not be taxed. There are also taxable bonds but why make that option when there are bonds that are not tied with federal, state and local taxes? But it also begs the question: Why is there an option for a taxable bond? Because the income from that type of bond is generally higher.
There are two types of municipal bonds: general obligation bonds or GOs and revenue bonds. The former is issued in order for government to have money to cover regular operational expenses. The latter is issued in order to fund infrastructure projects. Low-risk investors enjoy these kinds of investments because they will definitely earn from it—after all, nothing can bankrupt the government. It is also another way to minimize tax bill.
Health Savings Account
This is another way to have reduced taxes. Since this is for your health, the government is not inclined to pose taxes on any contributions to the Health Savings Account. If you put in the maximum amount possible, the account will grow and you don’t have to worry about tax. Of course, there may be a time that you will need the fund, say an emergency medical expense or even a scheduled medical procedure, withdrawals from such account will not be taxed as well.
Get an expert opinion
When you go through the IRS website, you will realize that there are so many tax credits that you could take advantage of that will help you reduce your taxes. Who knows better about these tax credits and forms of tax relief than tax experts like a certified public accountant, tax lawyer or an enrolled agent. Hire an expert to help you get maximum tax credit in order to minimize tax due. You should not worry about the professional fee because for sure, it would be offset—yes, that word is repeated over and over because that’s an important word when talking about minimizing tax—by the possible savings you will get in the end.
Taxes are never easy—paying them and calculating them. During tax season, many people are left scratching their heads over the simplest tax matters as filling out the forms. But the most headache-inducing part of tax season is the actual paying of taxes. Because it is usually a one-time thing—unless of course you apply for some sort of tax relief—it is a heavy burden. Other countries deduct taxes from an person’s regular income, making it less burdensome for the taxpayer both financially and mentally. But since that is not Uncle Sam’s way, taxpayers have to endure every year in what is known as tax season. It is an obligation that every American must settle if people want to continue enjoying the perks of living in the Land of Opportunity.