Although we are all obligated to pay our fair share of taxes, few of us would be pleased to pay taxes unnecessarily. Because taxes lower the actual return on your investments, you should be interested in legitimate ways to minimize taxes on your investment portfolio. Several approaches and strategies exist, including the following.
The basic strategy for year-end tax planning is to time your income so that it will be taxed at a lower rate, and to time your deductible expenses so that they may be claimed in tax years when you are in a higher tax bracket. Year-end planning involves not only a review of your income and deduction situation but also the use of checklists and a marginal tax rate analysis to help you minimize taxes.
Generally speaking, taxes should be postponed whenever possible. However, there can be circumstances that warrant paying your taxes sooner rather than later--for instance, if you anticipate being in a higher tax bracket in the future, or if you know that new or higher taxes are to take effect in the near term.
It's important to manage income taxes on your investment in retirement. In addition to considering the capital gains consequences of investment decisions, you should manage and control your investment income so that your Social Security benefits either will not be taxed at all or will be taxed only minimally. In addition, you must ensure that required minimum distributions from pension plans do not push you into a higher tax bracket.
If your assets are such that you're concerned about minimizing estate taxes on your portfolio, you should pursue strategies today to minimize taxation. Review your investment portfolio for estate freeze possibilities (which remove future appreciation of your assets from your estate) and consider gifting to loved ones.
You can also minimize taxes by investing in tax-efficient mutual funds that never pay dividends that purchase securities immediately after they have made large dividend/interest payments, or that try to limit capital gain exposure. You also should try to delay purchase of mutual funds or stocks until after it distributes income, dividends, or capital gains.
Caution: Investing in mutual funds involves risk, including possible loss of principal.
Understanding how to use capital losses effectively can make a difference in your portfolio's after-tax return. If you expect to recognize a capital gain this year, you should review your investment portfolio for possible capital losses to offset gains. Likewise, if you have any capital loss carryforwards, you should review your portfolio for capital gain opportunities to make use of the capital losses.
Understanding how to use tax credit programs as part of our investment portfolio can provide significant advantages. The low-income housing credit and the qualified rehabilitation expenditures credit may provide you with income, tax credits, and tax deductions.
If the value of your investments has increased substantially, and you are concerned about capital gains, there are several strategies you may consider to minimize taxation of highly appreciated assets. If you have more income than you need and are searching for ways to minimize your taxes, you might consider gifting unneeded income-producing assets to relatives who are in lower tax brackets.
If you borrow money from a broker to finance your purchase of stock, you may be able to deduct the margin interest on your tax return.
Caution: Where a margin account holds dividend-paying stock, certain considerations apply. Qualifying dividends paid to individual shareholders from domestic corporations (and qualified foreign corporations) are taxed at long-term capital gains tax rates rather than as ordinary income. However, for purposes of the deduction for investment interest (which is limited to net investment income), investment income is not considered to include qualifying dividends subject to tax at capital gains tax rates. Individuals may elect to treat such dividends as investment income for purposes of deducting investment interest, but doing so makes the dividends ineligible for taxation at capital gains tax rates.
Caution: Similarly, long-term capital gains are generally not included in net investment income for purposes of determining deductible investment interest unless an election is made to pay tax on the capital gains at ordinary income tax rates.
IMPORTANT DISCLOSURES: Broadridge Investor Communication Solutions, Inc. does not provide investment, tax, legal, or retirement advice or recommendations. The information presented here is not specific to any individual's personal circumstances. To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances. These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable — we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice.