Tips to help lower your tax bill with year-end planning

Q: It seems like each year I end up paying more in taxes than I anticipate, often due to investment income and capital gains taxes.  What can I do to plan better and maybe reduce some of my tax bill for the year, if anything?

A: As the end of the year draws near, the last thing anyone wants to think about is taxes. But if you are looking for ways to minimize your tax bill, there’s no better time for tax planning than before year-end. 2020 certainly continues to be a year full of surprises.  Fortunately, there are a number of tax-smart strategies you can implement to help limit any surprises when it comes to your taxes for 2020 and the years ahead.  Consider how the following strategies might help to lower your taxes. 

Put Losses to Work 

If you have capital gains, IRS rules allow you to offset your gains with capital losses. Short-term gains (on assets held one year or less) are reduced by short-term losses, and long-term gains (on assets held longer than a year) are reduced by long-term losses. If your net long-term capital gain is more than your net short-term capital loss, the net capital gain generally is taxed at a top rate of 20%.1 A net short-term capital gain, on the other hand, is taxed at ordinary rates, which range as high as 37%. To the extent that losses exceed gains, you can deduct up to $3,000 in capital losses against ordinary income on that year’s tax return and carry forward any unused losses for future years. 

Given these rules, there are several actions you should consider: 

Avoid short-term capital gains when possible, as these are taxed at higher ordinary rates. Unless you have short-term capital losses to offset them, consider holding the assets until you’ve met the long-term holding period (generally, more than one year). 

Take a good look at your portfolio before year-end and estimate your gains and losses. Some investments, such as mutual funds, incur trading gains or losses that must be reported on your tax return and are difficult to predict. But most capital gains and losses will be triggered by the sale of the asset, which you usually control. Are there some winners that have enjoyed a run and are ripe for selling? Are there losers you would be better off liquidating? The important point is to cover as many of the gains with losses as you can, thereby minimizing your capital gains tax. 

Consider taking capital losses before capital gains, since unused losses may be carried forward for use in future years, while gains must be taken in the year they are realized. 

When determining whether or not to sell a given investment, keep in mind that a few down periods don’t mean you should sell simply to realize a loss. Stocks in particular are long-term investments, subject to ups and downs. Likewise, a healthy unrealized gain does not necessarily mean an investment is ripe for selling. Remember that past performance is no indication of future results; it is expectations for future performance that count. Moreover, taxes should be only one consideration in any decision to sell or hold an investment. 

IRAs: Contribute, Distribute, or Convert 

One simple way of reducing your taxes is to contribute to a traditional IRA, if you are eligible for tax-deductible contributions. Contribution limits for the 2020 tax year — which may be made until April 15, 2021 — are $6,000 per individual and $7,000 for those aged 50 or older. Note that deductibility phases out above certain income levels, depending upon your filing status and whether you (or your spouse) are covered by an employer-sponsored retirement plan. 

An important year-end consideration for older IRA holders is whether or not they have taken required minimum distributions (RMD’s).  Due to COVID-19, the IRS has suspended RMD’s for 2020 – so if you have not taken them already, and you do not need the money, you may wish to consider holding off this year.  As of now, the plan is for RMD’s to begin again in 2021.

Another consideration for traditional IRA holders is whether to convert to a Roth IRA. If you expect your tax rate to increase in the future — either because of rising earnings or a change in tax laws — converting to a Roth may make sense, especially if you are still a ways from retirement. You will have to pay taxes on any pretax contributions and earnings in your traditional IRA for the year you convert, but withdrawals from a Roth IRA are tax free and penalty free as long as you’re at least 59½ and at least five years have passed since you first opened a Roth IRA. If you have a nondeductible traditional IRA (i.e., your contributions did not qualify for a tax deduction because your income was not within the parameters established by the IRS), investment earnings will be taxed but the amount of your contributions will not. The conversion will not trigger the 10% additional tax for early withdrawals. 

Charitable Giving

Finally, you may also wish to consider year-end charitable giving, which may be deductible on your taxes, depending on the amount of other deductions you have.  You may certainly gift cash, but you may also wish to consider gifting appreciated investments, which may help reduce your capital gains taxes as well.  I strongly suggest you run any charitable strategies past your tax and financial advisors to see what may make the most sense in your situation.

These are just a few steps you can take before year-end to potentially help lighten your tax burden. Again, please work with a financial professional and tax advisor to see what you can do now to reduce your tax bill. 

Source/Disclaimer: 

1A 3.8% tax on net investment income may effectively increase the top rate on long-term capital gains to 23.8% for single taxpayers with a modified adjusted gross income (MAGI) of more than $200,000 and to those who are married and filing jointly with a MAGI of more than $250,000.

Jeremy R. Gussick is a Certified Financial Planner™ professional affiliated with LPL Financial, the nation’s largest independent broker-dealer.*  Jeremy specializes in the financial planning and retirement income needs of the LGBT community and was recently named a 2020 FIVE STAR Wealth Manager as mentioned in Philadelphia Magazine.** He is active with several LGBT organizations in the Philadelphia region, including DVLF (Delaware Valley Legacy Fund) and the Independence Business Alliance (IBA), the Philadelphia Region’s LGBT Chamber of Commerce.  OutMoney appears monthly.  If you have a question for Jeremy, you can contact him via email at [email protected]

Jeremy R. Gussick is a Registered Representative with, and securities and advisory services are offered through LPL Financial, a Registered Investment Advisor, Member FINRA/SIPC.

This article was prepared with the assistance of DST Systems Inc. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. This communication is not intended to be tax advice and should not be treated as such. We suggest that you discuss your specific situation with a qualified tax or legal advisor. Please consult me if you have any questions. To the extent you are receiving investment advice from a separately registered independent investment advisor, please note that LPL Financial LLC is not an affiliate of and makes no representation with respect to such entity.  

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