There’s still time to take advantage of tax rules affecting stocks in your taxable portfolio or brokerage account that could help you save on taxes next April. But remember that the end of the year is fast approaching, and it takes time for stock transactions to settle.
Make sure you leave about 10 days or more to make sure all of your tax-driven sales or purchases are recorded in 2023.
First, let’s review the rules around capital gains and taxes on dividend or interest income.
• On short-term capital gains (that is, investments that are sold within 12 months of purchase) and ordinary income, you’ll pay federal income taxes at rates up to 40.8%. This rate combines the top income tax rate of 37% plus the 3.8% Affordable Care Act (ACA) tax on net investment income (the so-called “NIIT rule”).
• Long-term capital gains taxes are levied at rates from 0% to 23.8%, depending on your income.
• You’ll also pay taxes on stock dividends at rates from 0% to 23.8%, depending on your income.
The important thing to notice is that taxes on short-term capital gains and ordinary income are 71.4% higher than the tax-favored rate of 23.8% on long-term capital gains and dividend income.
There are two year-end tax-saving strategies that could cut your tax bill in April:
Reduce the high taxes on short-term capital gains and ordinary income (up to 40.8%).
Look at your portfolio for stocks you want to unload (either because they no longer fit your overall investment goals or are unlikely to recover in value in the foreseeable future). Consider selling these shares when you can offset short-term gains subject to high tax rates such as 40.8%, with long-term losses (up to 23.8%). This strategy is called tax loss harvesting, and it could be an effective way to rebalance your portfolio if your target asset allocation has veered away from your desired percentages.
Furthermore, you’ll want to consider using available long-term losses to qualify for the $3,000 deduction allowed against ordinary income.
Remember that tax-selling shouldn’t be undertaken simply for the sake of reducing your tax bill. You’ll need to consider the long-term prospects for each stock in your portfolio, especially those that have a very low-cost basis. Before selling a stock for below what you think is its intrinsic value or its future earnings prospects, consider whether the stock price could improve in the next year or two. Don’t let the tax tail wag a good stock that’s temporarily out of favor.
Consider donating appreciated stock rather than cash to a qualified charity.
If you are thinking about giving to a favorite charity before the end of the year, consider donating appreciated stock rather than cash. This is because the gifting of stock potentially offers a greater tax benefit. For one, you can deduct the fair market value of the stock as a charitable donation, and two, you won’t have to pay any of the capital gains taxes you would have had to pay if you sold the stock.
Let’s say you bought shares of a publicly traded stock for $50,000, and now it’s worth $100,000. If you were to decide to give it to a qualified organization such as a 501(c)3 charity, you would get a tax deduction for $100,000, and you would pay no taxes on the $50,000 in (unrealized) profit.
Two caveats to keep in mind: first, your deduction for donating appreciated stock to a 501(c)3 organization is not allowed to exceed 30% of your adjusted gross income — see IRC Section 170(b)1(C)(i) — and, second, if your publicly traded stock donation exceeds 30%, the law will allow you to carry forward the excess until it is used, for up to five years — IRC Section 170(b)1(C)(ii).
Finally, don’t forget the value that a financial adviser brings when evaluating these two year-end tax-planning strategies. Keeping more of your investment gains and limiting the negative effects from investment losses takes a careful eye, judicious timing, and seizing opportunities to offset gains and losses.
Wealth Enhancement Group does not provide tax or legal advice. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
Bruce Helmer and Peg Webb are financial advisers at Wealth Enhancement Group and co-hosts of “Your Money” on WCCO 830 AM on Sunday mornings. Email Bruce and Peg at firstname.lastname@example.org. Securities offered through LPL Financial, member FINRA/SIPC. Advisory services offered through Wealth Enhancement Advisory Services, LLC, a registered investment advisor. Wealth Enhancement Group and Wealth Enhancement Advisory Services are separate entities from LPL Financial.
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