Monday, December 16, 2013

Year-End Tax Strategies, What Else?

Phil DeMuth for Forbes writes: I don’t know if this is the best of all possible worlds, but it’s certainly the most expensive (Woody Allen).  If you are one of those types who don’t enjoy writing a prodigious check to “U.S. Treasury” come April 15th, here are a few tips, tricks and licks you might try for kicks on Route 66.   I am not a tax attorney so this is for your amusement only: check with your own tax consultants before you try this at home, or the IRS will come get you and your little dog, too.

Harvest Tax Losses
Do you have any stocks that have lost money?  What – even in a year when the U.S. stock market is up over 25%?  Ha!  Loser!
Actually, not.  If everything is up, it probably means that you are underdiversified.  You might well have stocks and mutual funds where your cost basis is higher than where they sit today, even if you are an extremely successful investor.  By selling them now, at least you can harvest a tax loss, taking lemons and making lemon meringue pie.  This is especially valuable if you can scrounge up any short-term capital gains to be applied against ordinary income.  The best places to hunt this year are in commodity, precious metals, bond, and emerging market funds.  Obviously this wisdom only applies to your taxable accounts, not your IRAs, 401ks, etc.
P.S. Secret Value Proposition: people selling their closed-end funds to harvest tax losses have driven them to deeper discounts to their net asset values than they usually trade at.  This could represent a bargain as prices regress to the mean over the coming months, if they do, and if you are “into” closed-end funds.  My genius nephew Chris DeMuth, Jr. has alerted me that Central Fund of Canada (ticker: CEF) is presently selling at a 5% discount to the price of the gold and silver that it holds.  In other words, you have a window where you can buy precious metals at a discount.  (Disclosure: I own a little bit of  CEF).
Harvest Tax Losses – a Deeper Dive
Even in positions where you have a net long-term gain, there may still be some tax lots within your total position that you purchased at a higher price than the security is selling for today. This especially holds where you have been reinvesting dividends and capital gains in mutual funds over time.  Go online to your custodian and examine the individual tax lots, specifying that you are selling just the ones that are currently underwater.
Check Your Account’s Tax Settings
Remember all those application pages you signed without reading when you opened your brokerage account?  Historically, most brokerages put you in “average cost basis” or “first in-first out” tax cost accounting when calculating your capital gains.  Recently, though, newer and better options have appeared on the menu – but you have to update your account settings to tell them which one you want them to use.   Look for “tax optimized” or “best tax” or “short-term tax-sensitive” among your choices.   That way, they will scan the individual tax lots when you sell and automatically select the ones with the least damaging tax consequences.
Roth IRA Conversions
If you anticipate even higher taxes in retirement, or if a Roth IRA will likely end up in your estate, it might make sense to do a partial Roth conversion, at least up to the top of your current tax bracket.  Check with your accountant for how much that might be.
Charitable Donations
Instead of writing a check to your favorite charity, make them a gift of whatever stock you own that has the lowest cost basis (ergo the highest embedded capital gains) that you’ve held for at least one year.  There is a lot to love about the donor-advised funds from VanguardFidelity, and Schwab that let you make tax-deductible charitable donations during your working years when they count, and then distribute the proceeds to charities on a timetable of your choosing (such as during retirement when the tax deduction might  be less valuable to you but the desire to give is still there).
Contribute to a 529 Plan
Do you know someone who could benefit from a college education (your child?), and is your state is one of the 34 that offer a tax deduction for contributing to a 529 Plan?  Check here.  If you are lucky enough to live in Arizona, Kansas, Maine, Missouri or Pennsylvania, they will give you a deduction for contributions to ANY state’s plan.  If you are fortunatae enough to live in a state that does not have an income tax, this is irrelevant (but maybe Junior should go to college anyway).
Most of these plans are not great, in terms of options and expenses.  Last time I checked I liked the Ohio CollegeAdvantage 529 Plan the best, because of its access to low-expense Vanguard funds and its asset-protection provisions, but others may be just as good or better.  Being the rogue that I am, I might be tempted to donate to my own state’s plan to get the tax deduction, then wait a year and move the money to another state’s plan that I liked better.  Provided this were kosher.  But of course I live in California, which offers no deduction at all despite having the highest state income taxes in the U.S.
Give Away Your Money
If your estate is going to be under $5.25 million, you might be feeling pretty smug about escaping estate taxes, but remember that your state might want to wet its beak a little, and some states have thresholds that start as low as $1 million.  Check here.  In the meantime, feel free to give $14,000 to everyone you know, tax-free.  Perhaps the best thing to give to your kids today would be $14,000 worth of stock in a family business that stands to appreciate over time, or any appreciating asset, for that mater, thereby removing the future appreciation from your estate.  Payments for tuition and medical care made directly to providers also generally bypass the gift tax as well.
Block those Capital Gains Distributions
Mutual funds are required by law to distribute their capital gains to shareholders by year end.  Yes, you can still receive capital gains even if you did not buy or sell shares personally during the year.  Investors who sell the fund before the ex-dividend date bypass this taxable event (after which the price of the fund falls by the amount of the payout).  After selling the fund, investors can either switch to a similar fund that is not making a capital gains distribution (perhaps a fund that has already made its year-end distribution), or simply wait a day to buy it back again after the dividend has been issued.
This requires a trip to the mutual fund’s website to find out the size and date of the distribution, and then checking your cost basis to make sure you would not realize capital gains in the transaction that would exceed the benefit.
Danger!  Be careful when harvesting a tax loss this way so you don’t get tripped up by the IRS “wash-sale” rules: either wait 31 days before buying back into the same fund, or buy a different fund that is not “substantially identical” to the one you sold.  P.S. No one knows what “substantially identical” means.  Allow yourself some berth here, as everywhere, in case you end up doing some fast talking to the man.
Finally, note that year-end is usually a bad time to buy mutual funds for the same reason, since they can immediately hand you back a portion of your money as a taxable event.  Thanks for nothing!


Post a Comment