As a part of this ruling, couples have the option to go back and amend their last three years tax returns, if they would have received larger tax refunds by filing a joint tax return. However, most people don't know whether it is financially beneficial to amend their returns or how to find out.
If you are not sure how amending your previous years tax returns will benefit you, you can check TurboTax new online decision tool to help you figure out if you have a refund coming for previous years and how you can easily file your amended tax returns.
Some of the tax benefits that legally married same-sex couples may now have at their disposal for 2013 and on their amended tax returns are:
Deductions and Credits for Dependents -- If you file married filing jointly, you will be able to take tax deductions and credits for your children, other dependents, or your spouse.
• Dependency Exemption -- The dependency deduction may mean an additional tax deduction of $3,900 per dependent and an additional $3,900 exemption for your spouse.
• Earned Income Tax Credit -- When you file as a married couple you may be eligible for an Earned Income Tax Credit worth up to $6,044 for 2013.
• Education Credits and Deductions -- Education is expensive, you may be able to claim a tax deduction on your taxes of up to $4,000 for your dependent or spouse's education.
Lower Tax Rates When Filing as a Married Couple
• There may be a possible reduction in your tax liability since tax rates are typically lower for couples filing married filing jointly. A married same-sex couple who earns $80,000 per year may see savings of at least $500 when filing jointly without considering additional deductions they will be entitled to.
Easier Tax Preparation and Savings on Costs
• Legally married same sex couples will have it easier when it comes to filing their taxes. A couple who previously had to file two separate federal taxes can now file one joint federal tax return. Same-sex couples may also save on tax preparation costs since they no longer need to pay high fees to have someone else prepare multiple federal and state tax returns. Instead, they can easily prepare one federal tax return and possibly one state return, together with tax software.
Savings for Your Families
• A surviving spouse in a same-sex marriage can now take advantage of the estate tax marital deduction, which allows an unlimited deduction from the gross estate of property passing to the surviving spouse.
• Legally recognized same-sex couples can now gift money and take advantage of a doubled annual gift tax exclusion of $28,000).
The ruling does not apply to registered domestic partnerships, civil unions, or similar formal relationships recognized under state law.
Kimberly Lankford for Kiplinger writes: People who itemize their deductions generally scramble to write checks before New Year’s Eve so they can deduct the contributions on their tax return for the year. But there may be more effective ways to give.
Donate appreciated stock. It’s been a good year for the markets, and some of your investments may have big gains. If you are planning a significant cash gift before year-end, consider donating appreciated stock or mutual fund shares instead. As long as you have owned the asset for more than a year, you can deduct the fair market value – not just the lower amount you paid for the asset. And you get that beefed-up deduction even though you don’t have to pay tax on the appreciation. Another advantage: You don’t have to establish your tax basis for the stock or shares, which may be hard to do if you’ve lost the purchase records or if the company has been involved in spinoffs and mergers. You deduct the value on the date of the gift. Contact the charity as soon as possible to ask what you need to do to transfer ownership of the shares. (Never donate assets which have declined in value. Sell first, so you can deduct the capital loss, and then give the proceeds to the charity.) See Charities: Give Stocks Instead for more information.
Donate your IRA required minimum distribution. If you’re over 70½, you may make a tax-free transfer of up to $100,000 from your traditional IRA to a charity before December 31, 2013. The money counts as your required minimum distribution but isn’t added to your adjusted gross income. This has two potential advantages over withdrawing the money (which would then count as taxable income) and donating the cash so you can offset the income with an itemized deduction. First, you score a tax break even if you don’t itemize. Second, by keeping the money out of your AGI in the first place, it can’t trigger tax consequences such as making more of your Social Security benefits subject to taxes or imposing the new surtax on investment income. The money must be transferred directly from your IRA to the charity to stay out of your adjusted gross income. See Who Can Transfer IRA Funds to Charity for more information about the rules, and Don’t Forget to Take Your IRA Required Distribution for tips on the timing of the year-end transfer.
Contribute to a donor-advised fund. These funds, run by brokerage firms, banks, mutual fund companies and community foundations, are a great way to fulfill your charitable impulses. And they’re particularly attractive at this time of year, if you’re racing to meet the deadline for 2013 contributions but haven’t chosen the charities you wish to support. Contribute cash, stock and funds (tax-free transfers from IRAs are not permitted) by December 31 and you can decide later which charities will benefit. Until you give the order, your money is invested. When you’re ready, you can usually direct the money to any qualified, 501(c)3 charity. Many families use these funds to allow multiple generations to get involved without setting up an expensive family foundation. “The grandparents may set up the fund around the holidays and tell each family that they have x dollars to give,” says Sara Montgomery, philanthropic services specialist with Wells Fargo Private Bank. “Then they all come to the dinner table a few months later and explain which charity they gave to and why it was meaningful to them.” Investment minimums vary by administrator. The minimum at Fidelity and Schwab is $5,000; at Vanguard, $25,000; and at Wells Fargo, $50,000. See Donor-Advised Funds: Contribute Now, Donate Later for more information.
Set up a scholarship fund.Although a lot of people would like to set up a scholarship fund to honor a deceased friend or relative, or to help a student pay for college, it can be a very complicated endeavor. But many colleges and community foundations make the process easy. You’ll generally need to invest at least $20,000 to $25,000 to endow a scholarship that will pay out $1,000 every year, although individual institutions set their own rules. For example, San Diego State University currently requires $50,000 to endow a $2,000 annual scholarship, or you can commit to giving $5,000 a year over three years to finance three $5,000 annual scholarships. The University of California, Los Angeles, requires $100,000 to endow a $5,000 annual scholarship, but you can create a scholarship for one year with just $1,000. The college or community foundation will manage the money and look for applicants, and it may even match your contribution. See Help Students by Funding a Scholarship for more information.
Consider noncash donations.You don’t have to give money to get the tax break. You can also donate clothes and household goods. If you itemize, you may deduct the fair market value of the item (which is based on its current condition and is usually a lot lower than the purchase price); for help determining the value, go to TurboTax’s ItsDeductible or the Salvation Army’s guide. You may also deduct, say, the cost of ingredients for a dinner you make for a soup kitchen or stamps for a charity’s mailing, and up to 14 cents a mile if you drive your car for charitable activities in 2013. Hold on to records and receipts in case the IRS asks. See How to Properly Claim Deductions for Noncash Donations and IRS Publication 526 Charitable Contributions for more information about what qualifies and when you need a receipt from the charity or an appraisal.
And as you scramble to make contributions before year-end, think about how much easier it would be if you had planned your charitable giving earlier in the year. “Make it a line item in your budget, just like you would for a mortgage or car payment,” says Montgomery. “Saving $5, or $50, a week is a lot easier than coming up with a lump sum all at once.” You could stash the money in a savings account or another separate account so it is ready whenever you choose to give. Setting aside money throughout the year also makes it easier to give after a disaster -- such as to support the victims of an earthquake -- which could occur at any time. See 6 Things You Need to Know About Giving to Charity for more information about checking out a charity.
Seth Fineberg for Accounting Today writes: A few key additions came in the cloud accounting arena along with a couple of noteworthy tech consultant moves amounting to a pretty busy week, even with the holidays around the corner.
One might think it would be relatively quiet news-wise this time of year, but several vendors and accounting/ERP consultants felt it was time to make (and announce) some moves that will have significant impacts on them in the new year and beyond. Here’s my take on it all:
News: Sage North America released an accountant edition of its entry-level cloud accounting product, Sage One. The Accountant Edition is free for accountants to use and will feature regular updates at least two times per month. Key features of the product include complimentary account access for the entire firm; unlimited user access and support; opportunities to win new clients, including client discounts; reduced data entry due to bank integration; and one login access to all Sage One clients.
My Take: For one, this is Sage following through on a promise made several weeks back when it said it wanted to have more products specifically for accountants; in fact, the company formed a specific business unit to do so.
The thinking behind this product is that, even though Sage One is primarily designed for truly small business, sole proprietors and independent contractors (i.e., 1-9 employees) these users still need an accountant to work with. As such, Sage wants them to be able to work with them more collaboratively and has built in features designed to do just that.
In addition, Sage is looking to connect more small businesses with the right practitioner and plans to do so via this product. Xero has had a similar plan in place with its product for some time as well.
Sage also promised more accountant-focused products to come by this summer so we’ll see, but for now this is the first logical step in that they are creating an accountant version of something already on the market. Now, as for these yet-to-be-named products, whether they will be cloud-based as with Sage One remains to be seen but we’ll keep an eye out.
News: Xero has officially released an integrated payroll offering as part of its cloud accounting platform, just months after announcing a beta version. While Xero still has third-party payroll relationships with ZenPayroll and SurePayroll, the integrated product is designed to be a seamless single accounting and payroll offering that automatically updates the general ledger, tax calculations, and tax alerts/filings, and provides employees easy access to their payroll information.
My Take: Here’s another one from the “We told you we were doing this and now it’s here” files. Xero has been building its own payroll offering for quite some time now and has been bursting at the seams to let everyone know about it as soon as it was ready for prime time. Back in September during its Xerocon user and partner event in San Francisco the company gave attendees a hint that it was on its way, offering a brief overview of what they’d see and even some beta testing.
Well, this week was the official unveiling of Payroll for Xero, which will allow users to access a fully integrated payroll product, which right now can be used in six states with more on the way likely through next year. And of course if that doesn’t work for Xero users, present or pending, they also can go with the third-party payroll relationships Xero already has.
It’s no surprise that having a payroll offering -- integrated or working with an existing accounting product -- is a big deal for firms. Look at all that’s out there on the market and you will likely see some kind of payroll partnership or internal offering. Heck, even Paychex -- one of the biggest payroll services in the country – decided that rather than waiting for the next cloud accounting vendor relationship to come its way it made a significant investment in Kashoo and rolled out its own branded cloud accounting offering (powered by Kashoo, of course). I had mentioned previously that it’s likely not going to be long before Kashoo will become a part of Paychex, much in the way SurePayroll has.
And, not to be outdone, Xero’s self-professed nemesis Intuit announced (albeit more quietly) that one in 12 Americans gets paid via Intuit’s payroll offerings and they have spent the last several months seamlessly integrating their online payroll into QuickBooks Online. Now within QBO, users can start paying employees in just three steps, right within the product.
Michael Lewis for Footprints writes: Working and living overseas is an adventure that few Americans get to enjoy. An estimated 6.3 million worked abroad in 2012 - many lived in exotic places, immersing themselves in a new culture often very different from that of the United States. But one obligation shared by U.S. citizens everywhere is the requirement to file and pay U.S. income taxes, regardless of domicile.
The United States is the only industrialized nation that taxes its overseas citizens, even if they are paying taxes elsewhere. As a consequence, if you are an expatriate - an American citizen living abroad - you should be aware of the income tax laws affecting you, as well as the opportunities you have to minimize their impact.
A U.S. Income Tax Return Must Be Filed
For all intents and purposes, U.S. citizens who have income from any source are required to file a U.S. tax return even if they live outside American borders. The only exception is for citizens whose income is below statutory filing limits. In 2012, these limits based upon filing status were as follows:
Single: $9,750; if 65 or older, $11,200
Head of Household With Dependent: $12,500; if 65 or older, $13,950
Married Filing Jointly (Both Spouses): $19,500; if 65 or older, $21,800
Married Filing Separately: $3,800
Failure to file a return may result in significant civil and possible criminal charges. Since the statute of limitations for an IRS audit is three years, it makes sense to file a return even if it is not required and no taxes are due, simply to start the clock running and eliminate possible future complications with taxing authorities. Recognizing the informational and logistical problems that often accompany an extended presence overseas, the law provides an automatic extension for the filing of tax returns from April 15 to June 15 for any year you are living abroad on the last day of the year.
State Income Taxes May Be Due
Forty-one states impose an income tax on their legal residents, even when living outside the country. Thirty-five of those calculate taxes based on federal income tax returns. Seven states - Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming - do not have a personal income tax. And six states - Alabama, Iowa, Louisiana, Missouri, Montana, and Oregon - allow federal income tax to be deducted when calculating the amount due.
Before moving overseas, astute citizens should consider transferring their legal domicile to a state that minimizes their tax liability. Once relocated to the optimum state, citizens can apply for a U.S. residency certificate (Form 6166). The application is made by filing Form 8802 with the IRS.
Tips to Reduce Income Tax Liability
While income tax liability is often inescapable, there are a number of provisions in the law to reduce taxes which might otherwise be due. While you have an obligation to pay taxes that are legally due, you also have the right to use tax benefits which may reduce the amount of taxes owed. In order to take advantage of most of the favorable tax treatments afforded to expatriates, you must satisfy either the physical presence test or bona fide residence test.
1. Foreign Earned Income Exclusion (FEIE) If your tax home is in a foreign country and you were physically present in that country for at least 330 days during a 12-month period, up to $97,600 can be excluded from your U.S. taxable income. American citizens who move from the country or return from their foreign assignments during the year may qualify for a partial-year exclusion by completing IRS Form 2555. If you don't qualify for the exclusion, but paid foreign income tax, you might qualify for a credit or deduction for the taxes paid in order to avoid "double taxation."
2. Foreign Housing Allowance Eligible housing expenses such as rent, utilities, insurance, rental of furniture, repairs, and parking (unless considered lavish or extravagant) are deductible up to 30% of the federal earned income exclusion, or FEIE, which is $97,600 (30% of which is $29,280). Fortunately, the law recognizes that some locations are more expensive than anticipated by the standard housing deduction. As a consequence, the IRS provides a higher deduction for certain high-cost areas detailed in IRS Notice 2013-31. Hong Kong, for example, allows a maximum deduction for 2013 of $114,300.
If housing is provided by your employer during an overseas assignment, it may be tax-free if it meets all of the following requirements:
It is provided on the employer's business premise.
It is furnished for the convenience of the employer.
You are required to accept the lodging as a condition of employment.
3. Deduction for Moving Expenses In order to deduct your moving expenses, you must maintain employment for 39 weeks in the new location. If you're self-employed, it's 78 weeks. When you move to another country, you can deduct all reasonable expenses of the move for yourself, your spouse, and any other members of your household. These expenses include household goods and personal effects, storage of your personal goods, and transportation and lodging as you travel from the old residence to the new residence. Be aware that if you claim the foreign earned income or housing exclusion, you cannot deduct the part of your moving expenses related to the excluded income.
4. Foreign Tax Credit Generally, the intent of the law is to protect citizens from paying tax on the same income to two different countries. Consequently, there is a dollar-for-dollar credit for any taxes paid to foreign countries on foreign earned income. Unearned income is subject to more complicated rules. You must choose between reducing your income by the FEIE and foreign housing allowance or using the foreign tax credit.
5. Benefits of Certain Tax Treaties The United States has negotiated specific tax treaties with more than 60 countries to reduce or eliminate double taxation for its citizens working abroad. These treaties also benefit foreign nationals working in the U.S. who might be adversely affected by double taxation, and they generally provide the following:
Exemption for or from U.S. tax on Social Security payments
Special credit for foreign tax paid on certain U.S. income
Deduction for contribution to foreign retirement accounts
Tax deferral on earnings in foreign retirement accounts until distributed
6. Social Security and Medicare Taxes Social Security and Medicare payments are governed by "totalization" agreements between the U.S. and over 20 other countries, and each one is different. However, temporary assignments of five years or less might only be subject to U.S. Social Security taxes depending upon the agreement between the country in which you work and the U.S. Your current resident country may even have its own retirement system similar to Social Security which you may be subject to. While U.S. Social Security and Medicare taxes don't always apply to foreign-earned wages, the following scenarios are most likely:
If you are an offshore employee of a U.S. corporation, that employer normally withholds Social Security and Medicare taxes on your W-2 earnings.
If you are working for a U.S.-based employer in one of the countries with a totalization treaty, you may participate in that country's social insurance system, and not have U.S. Social Security and Medicare taxes withheld from your U.S. pay.
If you are a bonafide employee of a foreign employer and are subject to laws governing a foreign social security tax, you are not required to pay U.S. Social Security tax.
7. Self-Employment Taxes If you are self-employed, you are obligated to pay U.S. self-employment tax, which is both the employer's and employee's share of Social Security and Medicare taxes. This must be paid in addition to regular U.S. income tax, and you must file IRS Schedule C and Schedule SE with your tax return. The self-employment tax rate is 15.3% of net Schedule C income before any foreign income exclusion or foreign tax credits.
Net earnings are income after all legal business expenses have been deducted and include income earned both in a foreign country and in the United States. The tax is equivalent to a Social Security tax of 12.4% and a Medicare tax of 2.9%. An additional 0.9% is collected from high-income earners ($200,000 and above for single filers, and $250,000 and above for filers who are married and filing jointly).
Final Word
Calculating and paying taxes while living out of the country can be confusing, even maddening. The requirement to report foreign bank deposits if funds total $10,000 or more is particularly burdensome and should be coordinated with tax calculations and payments. Unless you have the time and expertise to devote to tax planning or have earned income below the levels required to report each year, you should consider seeking the advice of a tax professional experienced with expatriate filers. The money you save is going to make the expense well worth it.
Investopedia writes: Income tax bracketshave been updated for the 2014 tax year (those taxes due on April 25, 2015), and for a change, a little bit of inflation may be a good thing for some filers. While the changes won’t be dramatic, anyone who expects to earn near the top end of a bracket will want to pay close attention and be sure to keep track of expenses carefully to avoid jumping into the next bracket.
The new tax brackets have been updated as mandated to prevent, among other issues, what is called bracket creep, where filers may end up in a higher income tax bracket while simultaneously getting less in credits due to inflation.
The changes to the tax rates are fairly minimal, but may especially be of interest to people who are normally on the very high end of one bracket, expect to earn more in 2014 than in prior years, or if much of the tax rate is dependent on writing off expenses. According to the Internal Revenue Service, the adjusted brackets are as follows:
2014 Taxable Income Brackets Structure
Tax Rate
Single Filer
Married Joint Filers
Head of Household Filers
10%
$0 to $9,075
$0 to $18,150
$0 to $12,950
15%
$9,076 to $36,900
$18,151 to$73,800
$12,951 to $49,400
25%
$36,901 to $89,350
$73,801 to $148,850
$49,401 to $127,550
28%
$89,351 to $186,350
$148,851 to $226,850
$127,551 to $206,600
33%
$186,351 to $405,100
$226,851 to $405,100
$206,601 to $405,100
35%
$405,101 to 406,750
$405,101 to 457,600
$405,101 to $432,200
39.6%
$406,751+
$457,601+
$432,201+
The change represents a savings of about $145 for a married couple earning about $100,000 after exemptions who are filing jointly. The standard deduction and personal exemption will also be adjusted slightly. The standard deduction will increase by $100, and for married couples filing jointly, it will increase by $200. The personal exemption will rise by $50.
2014 Standard Deduction and Personal Exemption Filing Status and Deduction Amount
Single: $6,200 Married Filing Jointly: $12,400 Head of Household: $9,100 Personal Exemption: $3,950 The alternative minimum tax (AMT) has also been adjusted for inflation and will now be regularly indexed to inflation. The 2013 exemption of $80,800 for married joint filers will rise by $1,300 in 2014. For single filers it will rise by $900 from the $51,900 level in 2013.
2014 AMT Filing Status and Exemption Amount
Single: $52,800 Married Filing Jointly: $82,100 Married Filing Separately: $41,050 Contributions to 401(k), 403(b) and most 457 plans will remain at $17,500 for those under 50 years of age. The $5,500 limit on contributions will remain unchanged for individual accounts such as Roth IRA investments. These will be adjusted to inflation, but only after increasing by a total of $500, and restrictions apply for some individuals who also have an employer-provided plan in addition to the individual plan. Much more detailed information on retirement and pension accounts can be found at IRS.gov.
Several provisions in the tax code won’t be adjusted for or indexed to inflation, including a new 3.8 percent investment income surtax on net income gained from investments. Also excluded is the 0.9 percent Medicare tax on earned income for joint filers making over $250,000, or $200,000 for single filers.
Income limits for the American Opportunity Credit also escape adjustment to inflation, with adjusted gross income remaining at $80,000 for single filers and $160,000 for married couples filing jointly. Many Americans use the latter credit for education-related expenses, so anyone near the limits and planning to use this credit should pay close attention to the numbers to avoid surprises at the end of the tax year.
The rate for the tax exclusion on annual gifts won’t change for 2014, which rose by $1,000 to $14,000 in 2013. However, the lifetime gift and estate tax exemption was made permanent and indexed for inflation for 2014, rising to $5.34 million per person, compared to $5.25 million in 2013.
Because the changes overall are modest, they will mostly be of concern to anyone at the high margins of each of the provisions. But for those who manage to stay in a lower bracket, thanks to the adjustments for inflation, the changes will certainly be welcome.
PriorTax writes: While filing your taxes, you can claim the standard deduction. This standard deduction varies on your filing status and allows you a deduction even if you haven’t saved any receipts over the tax year. Although most taxpayers take the standard deduction, there are some that itemize deductions and in return reduce more of their taxable income and able to claim a larger deduction.
If you’re wondering if itemizing your deductions is for you, you should first determine if your itemized deductions total to a number larger than the standard deduction amount. If you are filing taxes for prior years or the current year, you must save all receipts that support your itemized deductions.
What is an Itemized Deduction?
Itemized deduction creates a decrease in a taxpayer’s federal taxable adjusted gross income. In other words, itemized deductions turn taxable income into non-taxable income and ultimately reduce taxable income.
These itemized tax deductions are IRS outlined and must be filed on your taxes and listed as itemized deductions on Schedule A. The sum of your listed deductions will be subtracted from income and leads to the amount of your final taxable income. These deductions must be supported by records, such as receipts.
The most important thing is to be sure your itemized deduction amount is greater than your filing status standard deduction amount.
Is There a List of Itemized Deductions?
There are certain categories of items that are allowed to be listed as an itemized deduction. They are as follows;
Medical, Dental, Prescription Drugs, Other Health Costs
State and local income taxes (or state and local sales tax)
Personal Property Taxes
Real Estate Taxes (Property)
Home Mortgage Interest
Investment Interest
Charity and Church Contributions
Fair Market Value of Non-Cash Contributions to charities and churches
Union Dues
Job Related Expenses (not reimbursed by your employer)
Union Dues
Purchasing or Cleaning cost of Uniforms
Personal losses due to theft or casualty
Expenses and Fees from Investments
Job-related education and professional development
Job-related travel
Expenses from a Home-office
Tax Preparation fees
Safe Deposit Box Fees
Gambling losses (from gambling winnings)
Are there minimums or limits?
Health Care Expenses: Are deductible if only they exceed 7.5% of your adjusted gross income (AGI).The amount that exceeds this percentage can be deducted as an itemized deductions.
Job expenses and miscellaneous deductions: Can be deducted only if they exceed 2% of your AGI, the amount exceeding this can be deducted.
Charitable Donations: Must be less than 50% of your AGI. Donations that you have paid capital gains tax on such as bonds, stocks, art works, or other assets are limited to 30% of your AGI.
Casualty and Theft Losses: Can be claimed if the loss exceeds $100 per loss event and exceeds 10% of your AGI
My Spouse and I are filing Separately, Can I Itemize my Deductions?
If you and your spouse are filing as “married, filing separately” and one of you itemized your deductions, the other must itemize deductions also or claim zero as the standard deduction.
Now that you know all about itemized deductions, do you know why itemized deductions were introduced to the tax return form in the first place? Well, itemized deductions were created as a social engineering tool to provide economic incentives to taxpayers for making donations to charities, buying houses, etc.
If you decide to take advantage of that incentive and itemize your deductions or instead, take the standard deduction, you can do so online with PriorTax. The user-friendly website helps you file your late taxes so you can focus on how you’re going to claim your current year deductions!
Tom Lydon for ETF Trends / Seeking Alpha writes: As December draws to a close, investors are mulling over their taxable investment accounts to assess capital gains for the year. While exchange traded funds are a tax efficient vehicle, investors shouldn't skimp on researching options as there are subtle differences in the tax code for varying structures.
First off, ETFs are generally more tax efficient, compared to mutual funds, because ETFs typically trade less as they try to passively track a benchmark and they utilize "in-kind creation and redemption" to diminish the capital gains tax burden on shareholders.
Stock ETF dividends and fixed-income ETF yields will be distributed to shareholders and are taxed like income from the underlying stocks or bonds through a 1099 statement, writes Michael Iachini CFA, CFP, Managing Director of ETF Research at Charles Schwab Investment Advisory, Inc.
Stock and bond ETFs are taxed at a current 23.8% maximum rate on long-term gains and ordinary, short-term maximum rates are 43.4% - as of 2013, a new Net Investment Income tax tacks on a 3.8% surtax for taxpayers with adjusted gross income surpassing a threshold limit.
Precious metals ETFs, like gold and silver, are structured as grantor trusts and are backed by the physical metal holdings. The IRS treats the investments as if the investor held the hard asset. Consequently, physical metal ETFs are taxed as collectibles with long-term gains at a maximum 31.8% tax rate and short-term gains taxed up to a 43.4% rate.
Commodities ETFs and other funds that utilize futures contracts to gain exposure to the underlying market are structured as limited partnerships. Consequently, investors may have to fill out a Schedule K-1 instead of Form 1099, and they may incur Unrelated Business Taxable Income (UBTI), which could be taxable in an IRA - most ETFs, though, provide K-1s in a timely manner and typically do not generate UBTIs. Futures-backed ETFs are taxed based on the 60/40 rule - 60% long-term gains at a maximum 23.8% rate and 40% short-term gains at a maximum 43.4% rate - regardless of how long the investor holds the ETF. Additionally, at the end of the year, the ETF must "mark to market" all outstanding contracts and treat them as if the fund sold those contracts, and investors would realize those gains for tax purposes.
Currency ETFs come in three structures: 1) Open-end funds, or '40 Act funds, are taxed like stock and bond ETFs at a maximum 23.8% long-term rate and maximum 43.4% short-term rate. 2) Currency ETFs structured as grantor trusts, similar to precious metals ETFs, but gains are always treated as ordinary income at a maximum 43.4% rate. 3) Funds structured as limited partnerships issue K-1 statements and follow the 60/40 long-term/short-term rule.
While trading ETFs, investors may come across exchange traded notes. ETNs are not ETFs. ETNs are a type of bond or debt security issued by an underwriting bank and subject to the credit risk of the issuer. Gains in stock, bond and commodity ETNs are taxed at a maximum long-term 23.8% rate and maximum 43.4% rate. Currency ETNs, though, are taxed as ordinary income at a maximum 43.4% rate.
Fidelity offers a comprehensive instruction on How to invest tax efficiently.
Find ways to help create a strategy that defers, manages, and reduces taxes.
You may know your tax bracket. But that’s not really what you pay. In fact, the average American pays about 11% of income in federal income taxes. But that average hides a great deal of variation: Some Americans pay nothing, and others pay more than 30%.1
What determines the percentage you will pay? A lot of it is based on how much you make, but you can affect your tax bill by knowing the rules, managing how you generate income, choosing what accounts you invest in, and taking advantage of potential deductions. In general, there are three strategies you can use to try to manage your federal income taxes:
Defer taxes with tax-advantaged accounts or investing strategies, such as 401(k)s, 403(b)s, IRAs, health savings accounts (HSAs), and products such as deferred annuities.
Manage your tax burden by employing strategic asset location, investing in lower turnover funds, understanding mutual fund distributions, and taking advantage of charitable gifts and capital loss deductions.
Reduce taxes now with federal-income-tax-free municipal bond income, or reduce taxes in the future with a Roth IRA or 529 college savings account.
“Taxpayers have levers they can pull to try to reduce their overall tax bill,” says John Sweeney, executive vice president of retirement income and investment insights. “By creating an investing strategy that looks at all the options, and incorporates the elements that make sense for your own circumstances and goals, you may be able to end up with a better outcome.”
Here are a few educational ideas that can help you enhance your investing strategy.
Defer taxes.
Saving for retirement is a big job. Savings accounts that offer tax advantages can help, and can be a key part of an overall tax strategy because they allow you to put off paying taxes. For savers, the key is to maximize the potential tax benefits of these accounts, if you and your adviser decide that attempting to defer taxes makes sense for you.
Take advantage of retirement accounts.
Among the biggest tax benefits available to most investors are the deferral benefits offered by retirement savings accounts such as 401(k)s, 403(b)s, and IRAs. These accounts can offer a double dose of tax advantages—the contributions you make may reduce your current taxable income, saving you cash this year, and any investment growth is tax deferred, saving you money while you are invested. In the case of HSAs, withdrawals used for qualified medical expenses could be triple tax free: tax-free contributions, earnings, and withdrawals. What's more, saving in these accounts can help lower your adjusted gross income, and that could help you avoid income limits for additional tax credits and deductions, like the student loan interest deduction or personal exemption. “That’s a reason why we think a top financial priority for most investors should be to take advantage of IRAs, 401(k)s, and other workplace saving plans,” says Sweeney.
Generally, the first step to tax-advantaged savings should be through workplace savings plans, IRAs, or both. But those accounts have strict annual contribution limit rules. If you are looking for additional tax-deferred savings, you may want to consider deferred variable annuities, which have no IRS contribution limits.
Manage taxes.
Taking advantage of tax-deferred accounts is a key step in building a tax strategy, but it’s only part of the story. You may have more opportunities for tax efficiency by being strategic about the accounts you use to hold the investments that generate the most taxes, choosing investments that may create less of a tax burden, and taking advantage of tax deductions to reduce your overall bill.
When considering taxes and investment selection, it is important to remember that old adage: Don’t let the tail wag the dog. That’s because taxes are an important factor in an investing strategy, but they certainly aren’t the only factor. The potential tax benefits of any strategy need to be viewed in the context of your overall investing plan. That said, there are some choices that can have a potential impact on your tax bill.
Match the right account with the right investment.
An asset location strategy may sound complex, and it can be, but the basic idea is straightforward: Put the investments that generate the most taxable income in accounts that provide tax advantages. Tax-efficient assets, like municipal bonds, stock index ETFs, or growth stocks you hold for the long term, may generate relatively small tax bills and may make more sense in a taxable account.
On the other hand, relatively tax-inefficient assets such as taxable bonds, high-turnover stock mutual funds, or REITs may be better kept in tax-advantaged accounts like 401(k)s, IRAs, and tax-deferred variable annuities. Of course, you also need to consider your overall asset allocation, the account rules, the potential tax implications of making changes, your investment horizon, and other factors before making any changes.
Consider investments that generate less taxes.
For taxable accounts, you want to factor in the potential tax implications of your investments. Passively managed ETFs have two major tax advantages compared with actively managed mutual funds. Actively managed mutual funds typically make more capital gains distributions than passive ETFs because of more frequent trading.3Moreover, in most cases, capital gains tax on an ETF is incurred only upon the sale of the ETF by the investor, whereas index and actively managed mutual funds pass on taxable gains to investors throughout the life of the investment.
Beyond choosing between ETFs, index funds, or actively managed funds, consider a tax-managed mutual fund or separately managed account. These investments use meticulous recordkeeping of tax lots and purchase dates, gains, and losses to manage the tax exposure of the portfolio. In some cases, managed accounts may be personalized to certain aspects of your tax situation.
Keep an eye on the calendar.
Like comedy, a good tax strategy requires timing. For instance, if you are considering investing in a mutual fund for your taxable accounts, you may want to consider the distributions history of that fund. Mutual funds are required to distribute any earnings they might have realized from interest, dividends, and capital gains to their shareholders every year, and investors are likely to incur a tax liability on the distribution. It doesn’t matter whether you have owned the fund for a year or a day, if you own it when it makes a distribution, you are obligated to pay taxes. To avoid this potential tax liability, pay close attention to the distribution schedules for any funds you own—and avoid purchasing fund shares just before the distribution date.
If you are thinking of selling a fund just before the distribution, you may want to reconsider. The downside of selling funds in an attempt to avoid a distribution is that depending how much you paid for your shares, you could generate a significant capital gain—and the tax bill to go with it. So you need to factor in the potential tax impact of your decision against other criteria, including your asset allocation strategy and market outlook.
You also need to be aware of how long you hold an investment. If you sell a fund or security within one year of buying it, any gain could be subject to short-term capital gains rates, as high as 39.6% in 2013—and some high earners may be subject to the 3.8% Medicare surtax as well. You can qualify for a lower rate on gains by holding assets for over a year—the highest rate for long-term capital gains is 20%, with the possible addition of the Medicare surtax.
Offset gains and income with losses.
Tax-loss harvesting is when you sell an investment in a capital asset like a stock or bond for a loss and use that to offset gains or income. It can be a powerful way to help you keep more of what you earn. Each taxpayer is allowed to use capital losses to offset capital gains, and up to $3,000 of net capital losses to offset ordinary income each year. Any losses not used in a given tax year can be carried forward and used in future years. So selling losing investments and using those losses to offset gains can be used to reduce your tax bill. The strategy is typically most effective during volatile markets, especially during downturns.
Tax-loss harvesting may feel counterintuitive, because the goal of investing is to make money, not to lose it. But everyone experiences investment losses from time to time, and if handled properly and consistently, this strategy can potentially improve overall after-tax returns. The challenge is that a systematic tax-loss harvesting strategy requires disciplined trading, diligent investment tracking, and detailed tax accounting.
Think about charitable gifts.
Giving to charity may not be the path to greater material wealth, but the use of charitable deductions can be a powerful part of a tax strategy for those who were planning to make donations. This can help with all kinds of tax strategies, from offsetting Roth IRA conversions to complex strategies such as charitable lead or charitable remainder trusts.
One way to make the most of charitable giving is to donate securities that have increased in value. You may donate the securities directly or use a donor-advised fund—these funds let you take an an immediate tax deduction and then give you the opportunity to make grants to different charities later. Donating appreciated securities lets you avoid paying capital gains tax or the new Medicare surtax, allowing you to donate more to charity compared with selling the stock and donating the proceeds.
Many investors with stocks that have significant gains are worried about the capital gains tax bill they may see down the road. If those investors are planning to make charitable contributions, donating securities with significant capital appreciation to charity may help them reduce their capital gains tax.
Let’s look at a hypothetical example to see how. Karen has $10,000 she wants to donate to charity. She also has a few hundred shares of stock that have grown in value from $1,000 to $10,000 since she bought them. She wants to make a donation and own the stock, and is looking to maximize the tax value of her donation. Here are two options:
She could donate $10,000 in cash, and deduct $10,000 from her current income (in general, the fair market value of long-term stock donations to public charities are limited to 30% of AGI).
Or, instead of donating $10,000 in cash to charity, she could donate $10,000 of her long-term appreciated stock. The charity doesn’t pay taxes on the sale of the stock, and so they still get a donation worth $10,000. Karen still gets the $10,000 income deduction. Now Karen can use the $10,000 of cash she would have used for her donation to buy back the shares at a higher price. For example, say she sells the stock two years later for $12,000. Her basis would be $10,000, meaning she will pay capital gains taxes on $2,000 worth of gains. If she hadn’t donated the stock, her basis would have been $1,000—meaning she would pay taxes on $11,000 worth of gains. By donating and repurchasing, she was able to lower her tax bill.
Reduce taxes.
While selecting tax-efficient investments and making the most of tax-deferred accounts may help to reduce your tax bill, it won’t eliminate taxes altogether. There are a few options available that do have the potential to generate income or earnings that you generally won’t have to pay federal income taxes on—including many municipal bonds, Roth IRAs, and college savings accounts.
Research tax-exempt municipal bonds.
With many muni bonds, whether you’re purchasing individual securities directly or through a fund, ETF, or separately managed account, you generally get federally tax-exempt income. What’s more, in many states, these bonds offer state tax–exempt income, too. That covers most municipal bonds but doesn’t apply to all municipal bonds, many private activity bonds, Build America Bonds, and other exceptions. When considering munis, it is important to note that the yield is typically lower than taxable bonds with similar credit ratings and maturity. A lower yield means they will have a higher duration, all else being equal, and and a higher duration means the bond may be more volatile in a rising interest rate environment. It also means that your tax bracket is a key factor to consider when evaluating a muni bond, along with traditional bond characteristics such as yield, maturity, and credit quality. The basic rule of thumb is that investors in higher tax brackets will be more likely to benefit from investing in munis.
Consider a Roth or Roth IRA conversion.
Instead of deferring taxes, you may want to accelerate them by using a Roth account. A Roth IRA contribution won’t reduce your taxable income the year you make it, but there are no taxes on any future earnings as long as you hold the account for five years and are age 59½ or older, disabled, or deceased, or withdraw earnings to pay for qualified first-time homebuyer expenses. That can make a big difference if you think your tax rate will be the same or higher than your current rate when you withdraw your money. There are also no minimum required distributions (MRDs) from a Roth IRA during the lifetime of the original owner.
Roth IRA contributions are only allowed for investors up to a certain income level, but those rules don’t apply to Roth 401(k)s, if your employer offers you one. Higher wage earners can also access a Roth through a conversion from a traditional IRA or 401(k). You pay federal income taxes now on the conversion amount but none on any future earnings—if you meet the requirements.
Seek tax advantages for college.
The cost of higher education for a child may be one of your biggest expenses. Like retirement, there are no shortcuts when it comes to saving, but there are some options that can reduce your taxes. For instance, 529 college saving accounts and Coverdell accounts will allow you to save after-tax money but get tax-deferred growth and tax-free withdrawals when used for qualified expenses. Grandparents can also make significant gifts to a 529 without incurring gift taxes. You may also want to consider EE savings bonds or prepaid tuition plans, which offer other tax advantages when saving for college.
Put a strategy into place.
There are lots of tax moves an investor can make. The key is to pull together a number of different strategies that make sense for your situation. Then be disciplined about sticking with your approach—either on your own, with a financial adviser, tax adviser, or with a professional money manager. Some people don’t want to spend any more time thinking about taxes than is absolutely necessary, but spending a little time assessing your situation and your options may help you keep a bit more of your money in your pocket.
