Karen Blumenthal for the Wall St Journal writes: For investors, 2013 has been a mixed blessing.
The broad stock market is up 16% year-to-date—but a number of new and higher taxes threaten to take a bigger bite out of gains.
The tax changes affect higher earners and include higher tax brackets and capital-gains rates, a Medicare surtax on investment income and new limits on deductions.
If you are thinking about locking in gains now, you also should consider the tax consequences. There aren't many ways around them. Selling your losers can offset gains, though two healthy years of market returns might not have left many weeds in your investment garden.
Instead, this might be the year for higher earners to think about being generous as a way of saving on taxes, either by donating appreciated investments directly to charity, giving them away as gifts or making contributions to a so-called donor-advised fund.
The tax-law changes affecting investors come in several flavors.
Individuals earning more than $200,000 and couples earning more than $250,000 might pay a Medicare surtax of 3.8% on at least some investment income, such as dividends, interest and capital gains on assets held at least a year.
In addition, individuals earning more than $250,000 and couples earning more than $300,000 could see their itemized deductions reduced. For instance, a couple with $400,000 in adjusted gross income and $50,000 in itemized deductions would see their total deductions reduced by 3% of the amount of their income that exceeds $300,000, or $3,000.
Finally, high earners—individuals with $400,000 or more in income and couples with $450,000 or more—won't only move to a higher tax bracket but also will pay close to 25% in taxes on long-term capital gains after surtaxes, up from 15% previously.
Giving away appreciated investments allows taxpayers to avoid the capital-gains tax altogether while also getting a tax deduction of up to 30% of their adjusted gross income. It also can save on state taxes, even in states where charitable deductions aren't allowed.
Here are some options.
Be charitable. You can donate appreciated assets directly to a charity if it is equipped to accept it. If you want to make several donations or you aren't yet sure where you want the funds to go, contributing to a donor-advised fund might make more sense.
Donations to such funds rise tax-free in the fund until donors specify charities, sometimes years later.
Last year, donors rushed to open new accounts in anticipation of tax-law changes, and the interest has continued. Schwab Charitable, a nonprofit donor-advised fund provider sponsored by Charles Schwab, SCHW -1.19% says it opened about 3,000 accounts in the first seven months of this year, up 20% from a year ago. Contributions to Schwab funds more than doubled during the period, to $471.4 million, while grants to charities were up 21%.
Kim Laughton, president of Schwab Charitable, attributes the gains to concerns about tax changes as well as greater awareness of the funds, which can be opened with a minimum contribution of $5,000 and can make grants as small as $50.
Though donors can only recommend where the money goes, the funds generally fulfill the request. Fidelity Charitable, a nonprofit fund provider sponsored by Fidelity Investments, will make donations to any legitimate charity.
It declines fewer than 2% of requests because an organization doesn't meet federal charitable standards. For example, more than 40,000 organizations claim to support veterans. Sarah Libbey, president of Fidelity Charitable, says the firm is researching how best to assess those charities' qualifications.
Both the Schwab and Fidelity funds charge annual fees of 0.6%, or $60 per $10,000 invested, with a minimum annual fee of $100.
Charitable donations—and the tax break—can be particularly helpful for those saddled with a long-term investment that has underperformed in recent years but has a large accumulated gain.
Jerry Lynch, a Fairfield, N.J., certified financial planner, says it also is a helpful strategy when the client has lost the original paperwork and can't determine the "cost basis," or what was paid for the investment.
Addressing required distributions. Investors 70½ and older this year can give up to $100,000 directly to charities from their individual retirement accounts, an efficient way to fulfill their required minimum distributions without having to withdraw taxable income.
Making gifts. A single person can give up to $14,000 per recipient this year without running into gift-tax issues, while a couple can give up to $28,000.
If you already were planning to make gifts to family members or others, you can give appreciated stock to those who are in the 10% or 15% tax brackets—individuals with income up to $36,250 and couples up to $72,500. Recipients inherit the giver's cost basis, but in those tax brackets, they don't pay tax on long-term capital gains.
Still, be aware that children through age 23 who are full-time students and listed as dependents on their parents' tax returns might have to pay taxes on some investment income at their parents' rates, a provision known as the "kiddie tax."
Another issue to consider: If the appreciated assets are inherited through an estate, the cost basis steps up to the value on the day of death. Given that $5.25 million is excluded from an estate's taxes, "it may make sense to wait," says Beth Kaufman, an estate lawyer at Caplin & Drysdale in Washington.
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