11 Ways To Cut Your Capital Gains Tax Bill

Ashlea Ebeling, for Forbes writes: Last year’s historically low capital gains tax rate of 15% is, well, history, but there are still ways around the new higher rates that went into effect Jan. 1. The 15% top capital gains tax rate went up to 20%. High income earners have to tack on another 3.8% (the net investment income surtax). Look at this before year-end if you want to avoid a surprise capital gains tax bill when you file your tax return next April.

“You start looking at these numbers, and it all adds up in a hurry,” says R. Jeremy Wilson, a CPA and financial planner with Draffin & Tucker in Atlanta. One elderly client with $7 million of stock with $6 million of built-in gain is going to hold onto it until death rather than sell or give it to her adult children now.  By running appreciated assets through your estate your heirs get your assets with a step-up in basis, and no capital gains tax is due. Call it the big deferral. Wouldn’t you rather pay 0% than 23.8% capital gains tax?

Luckily, there are ways to exploit the 0% rate while you’re alive. Those in an ordinary income tax bracket of 15% or below can sell stock at a 0% gains rate. For 2013 a couple can have up to $72,500 and a single up to $36,250 in taxable income and still be in the 15% ordinary income bracket. Add in the standard deduction and personal exemptions, and that translates into an adjusted gross income of up to 92,500 for a couple and $46,250 for a single filer. Take enough gains to fill up that 15% bracket.

If you’re in a high bracket but your adult children or parents aren’t, consider giving them appreciated stock. You can give $14,000 a year in cash or property each to as many individuals as you’d like without eating into your lifetime gift/estate tax exemption. The recipient of your stock gift takes on your basis—and later sells at the 0% rate.

Rethinking your retirement savings strategies can also help. A young doctor who’s right on the cusp of getting hit with the 3.8% surtax (for singles earning more than $200,000/couples earning more than $250,000) was making his 401(k) contributions 50% pre-tax and 50% after-tax. He’s shifted it to 75% pretax to keep him under the threshold for owing the 3.8% surtax, on the advice of his CPA, Stephen Bigge with Keebler & Associates in Green Bay, Wisc. “Don’t be allured by the tax-free nature of the Roth,” Bigge warns, adding that a 100% Roth 401(k) allocation makes sense for those who expect to be in the highest marginal tax bracket indefinitely, are in the lowest tax brackets, or are in lower tax brackets today but expect to be in higher brackets when they pull the money out.

Bigge is also helping clients ladder stock sales or exercise options over a period of time so as not to trip the top 20% rate and the surtax. Some clients are increasing their exposure to municipal bonds and making oil & gas investments so as to get the intangible drilling costs as a pre-AGI deduction to keep their income below the thresholds for the taxes kicking in.

If you don’t want to change your investment mix, you can focus on basic strategies like harvesting losses to offset gains. Or take gains avoidance a step further. Philip Clinkscales, a financial planner with Sound River Advisors in Atlanta, sells out of mutual funds just before the fund manager declares capital gains payouts for the year, buys a similar exchange traded fund, and then buys back the actively managed fund.

Sometimes rebalancing just means paying gains tax, and shouldn’t you be happy you have gains in the first place? Wilson advises a couple in their 30s, a lawyer and a corporate executive who earn $1 million and were rebalancing their portfolio and looking at more than $100,000 in gains. They were basically stuck with the 23.8% rate. “I told them, ‘Let’s just be thankful that in the current economy you both have that kind of income,” he says. “I would always take paying the tax with a gain as opposed to offsetting my income with a loss.”

Check out these strategies to bypass capital gains altogether or at least lessen the bite.

1. Invest In Your Primary Residence. Individuals can exclude up to $250,000 of gain in their primary residence, making it one of the greatest tax shelters out there. Married couples get a $500,000 exclusion. Keep receipts of capital improvements like a new roof or kitchen faucet that add to your home’s cost basis.
2. Manage Your Tax Bracket. If you keep your taxable income down (by stuffing pre-tax retirement accounts if you’re working, or taking no more than your required minimum distributions from your IRA if you’re retired), you can take just enough gains to stay in the 15% bracket and then your capital gains rate is 0%.
3. Harvest Losses. Don’t forget to look at the losers in your portfolio, and consider selling to harvest losses and offset any gains. “People are always going to have assets in their portfolio that have losses,” says Bigge.
4. Gifts To Family Members. You can make annual exclusion gifts of up to $14,000 per individual each year. If you give highly appreciated stock to your child or parent, he takes your low basis but when he sells it – if he’s in a lower bracket – his capital gains rate is 0%. (Special rules apply to kids under 25.)
5. Gifts To Charity. Instead of selling appreciated stock and giving cash to your favorite charity, give appreciated stock. The tax benefits are twofold:  you get a deduction for the fair market value of the stock (up to 30% of your adjusted gross income), and capital gains taxes do not apply.
6. Feed Retirement Accounts. Once you stuff after tax money into a Roth, all future growth and distributions are tax-free. Yep, that means no capital gains tax.
7. Open A 529 College Savings Account. The money you sock away in a 529 college savings plan grows tax-free and withdrawals for education expenses are tax-free (i.e. no capital gains).  Open an account when your kids are tots, and stick to direct sold plans with low-cost index funds.
8. Buy And Hold. Stock left to heirs gets an automatic step-up in basis to its current market value at the date of your death, so you escape capital gains tax.
9. Move To A Tax-Friendlier State. State capital gains taxes take another bite—as high as 13.3% in California. If you might move to a state without an income tax, such as Florida or Nevada, consider holding off on a sale that would otherwise trigger state capital gains tax.
10. 1031 Exchanges. This strategy is primarily for real estate investors (but it also works for artwork). You roll all the capital gains from the asset you’re selling into a new building (or artwork), which takes on the old property’s low basis. Even if rates don’t go down, you’ve had the money working for you that would have gone to pay taxes.
11. Charitable trusts. With a charitable remainder unitrust, y ou put $100,000 or more into a trust that pays out income to you for your life, with what’s left going to charity at your death. If you put appreciated assets in the trust—say a vacation home—you defer a big capital gains tax hit. If you’re in a low enough bracket when you take the payouts, you avoid the capital gains tax altogether.

For a look at tax reform proposals around the preferential rates on capital gains, click here for a report from the Committee For A Responsible Federal Budget.

Tax Credits vs. Tax Deductions: What's the Difference?

TopTaxDefenders write: Around tax time, it's common to hear phrases such as "tax deduction" or "tax credit" being used interchangeably. While it can be easy to assume that tax deductions are tax credits are the same, they're actually different and they affect your tax liability in different ways. Which one is best to use on your tax return? Here's a primer on the difference between a tax deduction and a tax credit. 

How Does a Tax Deduction Work?

A tax deduction works by reducing the taxable income an individual has to report. Some common tax deductions include student loan interest, moving expenses, self-employment tax, child support, and IRA contributions. The most commonly used tax deduction is the standard deduction that is automatically granted based on the taxpayer's filing status. Taxpayers who use these deductions can subtract them from their gross income, which indirectly reduces their potential tax liability.

For example, in 2013 a single person who earns $30,000 in total income is eligible to deduct $6100 as his or her standard deduction. If this is the only tax deduction he or she qualifies for, then the adjusted gross income for the year will be $23,900 (30,000 - 6,100). This means that the taxpayer will only have to calculate tax on $23,900 that year, rather than the original $30,000.

How Does a Tax Credit Work?

A tax credit, though, works differently. Rather than reducing taxable income, a tax credit directly reduces the amount of tax owed. Credits are subtracted from the actual tax liability as calculated on the form. There are both refundable and nonrefundable tax credits. Nonrefundable tax credits can only be used to reduce tax liability. On the other hand, refundable tax credit can be issued as a refund to the taxpayer. For example, the Child Tax Credit is a nonrefundable credit. Those who qualify for the Child Tax Credit can subtract up to $1,000 of their total tax liability for each qualifying child. Since the credit is nonrefundable, though, it can only reduce the tax owed. A taxpayer who owes $2,000 in tax and has three qualifying children, therefore, can only claim a maximum of $2,000 in Child Tax Credit.

However, a refundable tax credit can both reduce the tax liability and be issued as a refund. The Earned Income Credit is an extremely popular refundable tax credit. Those who qualify for it can receive the additional credit as a refund. For example, a taxpayer who owes $2,000 in income tax and is eligible for $3,500 in Earned Income Credit will owe no income tax at all, since $3,500 is larger than $2,000. However, he or she can also receive the additional $1,500 as a refund.

Both tax deductions and tax credits can be extremely beneficial for taxpayers. They both reduce the amount of tax owed at the end of the year. Understanding the difference, though, can help taxpayers prepare their taxes or plan for their tax liability accordingly.

Claim energy efficiency tax credit for homeowners before it’s gone

Steve Fishman writes: The federal government wants to encourage homeowners to make their homes as energy efficient as possible. To do so, back in 2005 Congress enacted a tax credit for “nonbusiness energy property.”

This was a tax credit (subject to a $500 lifetime cap) for certain energy efficiency improvements to a taxpayer’s existing principal residence. The credit expired at the end of 2011, but was brought back from the dead by the fiscal cliff tax deal back in February. It was made retroactive to apply to 2012 and then expire at the end of 2013.

So, if you haven’t used up your lifetime $500 limit already, 2013 could be your last chance to do so.

You may claim a credit of 10 percent of the cost of certain energy-saving property that you added to your main home. This includes the cost of qualified insulation, windows, doors and roofs. You can claim no more than $200 in total credits for doors.

You can also obtain the credit if you install specified types of “qualified residential property.” You can get a credit equal to the full cost of the equipment up to the following caps:

• advanced main air circulating fan: $50
• natural gas, propane, or oil furnace or hot water boiler with an annual fuel utilization rate of 95 or greater: $150
• electric heat pump water heater with an energy factor of at least 2.0: $300
• electric heat pump that achieves the highest efficiency tier established by the Consortium for Energy Efficiency: $300
• central air conditioner that achieves the highest efficiency tier established by the Consortium for Energy Efficiency: $300
• natural gas, propane or oil water heater that has either an energy factor of at least 0.82 or a thermal efficiency of at least 90 percent: $300
• biomass stoves that use “plant-derived fuel available on a renewable or recurring basis, including agricultural crops and trees, wood and wood waste and residues (including wood pellets), plants (including aquatic plants), grasses, residues and fibers”: $300

Such property must meet certain energy efficiency requirements for you to qualify for the credit. For purposes of taking the credit, you can rely on a manufacturer’s certification in writing that a product is qualified residential energy property. Do not attach the certification to your return. Keep it for your records.

Are You Including all Your Medical Expenses in Your Tax Deduction Calculation?

KRD writes: Take the time to evaluate medical expenses that may allow you to surpass the threshold for a tax deduction.   Although there are several medical deductions, this may be a few ideas that may not be on your radar for deductible expenses.

Eyeglasses/Contacts:  Not only can you include the amounts you pay for eyeglasses and contact lenses needed for medical reasons, you can also include the cost of equipment and materials required for using contact lenses, such as saline solution and enzyme cleaner.

Hearing Aids-including maintenance:  Include the cost of a hearing aid as well as the batteries, repairs, and maintenance needed to operate it.

Chiropractor:  You can include in the medical fees you pay to a chiropractor for medical care.

Transportation:  
Include transportation primarily for and essential to, medical care.

• Bus, taxi, train, or plane fares or ambulance service.
• Car expenses. You can include out-of-pocket expenses, such as the cost of gas and oil, when you use a car for medical reasons. You cannot include depreciation, insurance, general repair, or maintenance expenses.  (Compare the standard medical mileage rate to the actual costs for the best option).

New Tax Law for 2013 Medical Deductions:  For 2013, you can claim deductions for medical expenses not covered by your health insurance that exceed 10 percent of your adjusted gross income (AGI).  This is an increase from the 7.5% threshold for 2012.  Note, however, for individuals or their spouses age 65 and older in 2013 there is a temporary exemption from January 1, 2013 to December 31, 2016 where the threshold remains at 7.5% of AGI.  Unfortunately, if you turn 65 in 2014, this exemption does not apply to you.

As Always, Keep Good Records:

• The name and address of each medical care provider you paid, and
• the amount and date of each payment.
• And statements or itemized invoices