So as you can see, the rates can get very high — even if you are not making a huge income. Having a proactive tax strategy can easily save you thousands each year.
Here are six tips for reducing the amount of money you're paying in taxes on your investments:
1.Do not buy a stock or fund unless you plan on keeping it for a year! When I review a client's Form 8949 that lists all the trades, I often find hundreds of short-term trades where they lose up to half the gain if they are right. At minimum, buy the stock for at least 1 year — or don't buy it!
2.Time your sales. If you need to sell a stock or fund because you have a large gain, review where you have losses that you can sell to offset these gains. The goal is to have losses offset all your gains plus an additional $3k that you can use to offset your regular earned income. This is known as "harvesting losses."
3. Reduce or eliminate taxable interest. Banks are paying almost nothing and on top of that, you are losing half of that in taxes. Look at tax-free money-market accounts and tax-free muni bonds, which generally have higher returns on an after-tax basis.
4. Sell higher-costing securities. Let's say that you have been buying Apple for years at all different prices ranging from $100 to $700. Sell specifically the $700 shares and now you have a "loss" for income-tax purposes, even though your stock is worth more than you paid for it. Most people use either "average price" or "first in, first out" and generally that increases the taxable gain.
5. Watch "turnover ratios" in mutual funds. This tells you how often a money manager turns over their portfolio. An index fund is basically zero vs. an actively-traded fund, where the ratio can be over 100 percent. At 100 percent or more, that entire gain is taxable at your highest possible rate vs. an index fund that is taxable mainly when you sell it — and at lower capital gains rates.
6. Give it away. If you are giving money to charity or family, give them appreciated stock so you do not have to pay taxes on the gain. Charities do not care if you give them dollars or doughnuts, as long as it converts into money. Family members may be able to sell the stock and pay no taxes (10- or 15-percent tax bracket), or a lower capital-gains rate than you if they are not subject to the new higher tax rates.
Jan. 1 is right around the corner. You have a few weeks to really impact your taxes for 2013, so take advantage of it. A vacation is always better when it is paid by the savings on your tax return!
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