If you aren’t vigilant, Uncle Sam has a way of taking a big bite out your portfolio.
And with 2016 winding down, time is running out for investors to take steps to lower their tax bill next April.
So before the buzzer sounds on this year, here are six year-end tax tips that, in my opinion, may help minimize the tax hit to your hard-won returns.
1) Tax Loss Harvesting
It’s been a volatile year in the stock market, and you may have some positions underwater.
If so, one way to reduce your tax liability is through tax-loss harvesting.
The basic idea is to sell losing investments before year-end to reduce the tax liability on capital gains on your winning investments.
Should you decide to buy back the security later, make sure you consult with a tax attorney first.
The IRS does not allow dumping a stock for tax purposes and turning immediately around and buying it back, a so-called wash sale.
There is usually a waiting period depending on the investment involved.
2) Capital distributions
You might also consider checking into whether your mutual funds or ETFs are making capital gain distributions before year-end.
Oftentimes a fund manager will decide to sell a stock to lock in profits or to raise cash for shareholder redemptions.
In such cases, the fund will then distribute at least 95% of the gains to shareholders and that’s a taxable event.
If the fund has already delivered robust returns in 2016 and you were considering selling it in 2017, it may make sense to sell before the record date of that capital gain distribution.
That same advice also holds for dividends. Check out the dates your fund is scheduled to pay out dividends.
If you hold a fund that will pay a dividend before December 31, you may want to do some math.
Compare the tax hit of recognizing a dividend payout against the capital gain tax hit you would absorb should you sell off the entire investment.
If the fund has already delivered handsome returns and you were thinking of selling at some point anyway, it might make sense to unload the investment in 2016, and before that dividend distribution, to lower your tax bill.
4) Retirement contributions
If you plan to max out on your contributions to your 401(k) or an IRA to save on a tax-deferred basis and lower your 2016 tax bill, now is the time.
Contributions to your 401(k) or other retirement plans need to be made by December 31.
The 2016 contribution limit is $18,000, or $24,000 for people age 50 or older.
5) Charitable giving
Writing a check to a charity is a tried and true tax savings strategy late in the year.
However, some investors also opt to donate stocks and bonds to a worthy cause.
The tax advantage is two-fold: You can deduct the current market value of the asset from your taxable income and you don’t have to worry about paying any tax on capital appreciation that you may have accumulated.
6) Flexible spending accounts
These flex plans allow employers to set aside money on a pre-tax basis to pay child care or medical bills.
Trouble is, these accounts follow the “use it or lose” rule.
So if you are concerned you won’t be able to spend the money in the account before the end of the year, all may not be lost.
The IRS does allow a grace period for this set-aside money until March 15. Check to see if your employer has adopted this program.
With a little bit of effort and planning, you may be able to lower your 2016 tax bill.
Why leave money on the table if you don’t need to?
DISCLAIMER: The information contained in this article is general in nature and is not intended as specific advice. Neither Covestor Limited nor its representatives are qualified to or engaged in rendering tax, accounting or legal advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, accounting or legal advice. You should consult a qualified professional regarding the effect of such considerations on the matters covered in this article or before engaging in any of the courses of action or transactions discussed in this article.
- Xavier Brenner has covered global market, business and economic trends for Interactive Brokers Asset Management since 2013. An experienced financial journalist, Brenner offers analysis and insights on the stories that matter to the discerning investor.