Smart tax management has always been a good way to help grow and preserve your wealth. But now it’s even more powerful.
The reason: Federal income tax changes that took effect in 2013 have raised the rate for those with high incomes. As a result, every dollar that you save in taxes is worth more than it was just a couple of years ago. With that in mind, we’d like to offer five strategies to help you keep more of what you earn.
1. Keep the cash, give securities. Cutting a check to your favorite charity may be the simplest way to contribute—but it’s typically not the most tax-efficient. That’s why donors are increasingly contributing appreciated stocks, bonds, or mutual funds rather than cash. When you donate a security that you’ve held for at least a year to a public charity, you’re entitled to claim the fair market value as an itemized deduction on your federal return. The deduction can amount to as much as 30% of your adjusted gross income. And because you’re donating the securities rather than selling them, you will owe no capital gains taxes.
2. Share the wealth. Long-term, appreciated securities are also a wonderful gift for adult children who are in a lower tax bracket than yours. If your children are in the 10% or 15% tax bracket, they’ll pay no capital-gains taxes. And since you’ve already held the securities for at least a year, the recipients can sell them right away with no tax repercussions. IRS rules for 2014 allow you to give up to $14,000 worth of securities or other property to as many individuals as you like, without filing a gift-tax return. You should consult with a tax professional on this to be sure you are not subject to the “kiddie tax”.
3. Consider a DAF. Donor-advised funds—or DAFs—are low-cost accounts offered by a sponsoring organization. You as the donor contribute cash, appreciated securities or tangible assets like real estate or even jewelry. When you make contributions, you receive an immediate, maximum tax benefit. Then you recommend grants from the DAF to the charity of your choice whenever you wish. Establishing a DAF can be an especially good way to protect assets from taxation when you have not had time to thoughtfully choose a charity. We explain the case for DAFs in more detail here.
4. Make liabilities disappear. Scour your taxable investment accounts for tax-loss harvesting opportunities. In tax-loss harvesting, you sell investments that are down for the year and use the realized losses to neutralize tax liabilities. The losses you harvest can be used to negate taxes owed on winning investments or ordinary income. Note that the IRS forbids you from selling a security for a loss and then buying it or a similar investment back within 30 days. Tax-loss harvesting is best handled in consultation with your advisor.
5. Give to receive. Many investors wish to convert from a traditional, tax-deferred IRA, to a Roth IRA, which is funded with after-tax dollars. What often stops them is the hefty tax that is immediately owed on money being transferred from a traditional IRA to a Roth. Paying the taxes with IRA assets is a poor idea, since it involves taking a taxable distribution—in other words, you’re taxed twice. One solution is to convert in the same year you claim a large tax deduction as the result of a charitable deduction. That deduction will help to neutralize the IRA conversion taxes.
Please don’t hesitate to contact us if you’d like to discuss ways to minimize your taxes. Meanwhile, the entire FPC Investment Advisory team wishes you and your loved ones a joyful holiday season.
Bijan Golkar is a Certified Financial Planner™ and licensed tax preparer with FPC Investment Advisory Inc. in the San Francisco Bay Area.