Broker Check

Managing Accounts for Tax Efficiency

| July 22, 2019
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If you make money—even if you’re just making money on your money by earning interest—you will need to pay taxes. Arthur Godfrey once said, "I'm proud to pay taxes in the United States; the only thing is, I could be just as proud for half the money." You might chuckle, but you probably agree with the sentiment. I think it’s safe to say that most of my clients do. 

The thing is, by understanding the tax rules and using some discipline in your investment strategies, you likely can reduce your tax burden.

Some High-Profile Examples

During the 2008 Presidential Election, candidate Mitt Romney came under scrutiny when it was discovered that the percentage of taxes he paid was lower than the percentage his secretary paid. President Trump has been under similar scrutiny as he was found to have paid no taxes during some years in the 1980s and 1990s. When confronted by Hillary Clinton in the 2016 debates about this topic, Trump replied, “That makes me smart.”  Maybe it wasn’t the most tactful response, but in at least some respect, it is true. He found out how to use the tax laws to his favor, and that’s smart. Regardless of your political leanings, you probably wonder what sort of tactics these men used to reduce their tax liability and if those same strategies might help you. 

Personal Application

Many people are familiar with some of the most common strategies to minimize tax burdens. But what happens when you’ve already maxed out your 401k, 403b, or 457 plan and are not eligible to contribute to (or have already maxed out) a Roth IRA? Or what if you’re retired and have investable or inherited money? How do you shelter or reduce tax exposure?  

I’ve outlined some simple ways we can invest money to potentially reduce your tax liabilities below.  Please remember, everyone’s individual circumstances are different. Please consult a tax advisor before implementing any of these strategies.

Invest in tax-free municipal bonds. Bonds are loans. If you loan money to municipalities, school districts, and state or local governments, the income derived from the loans is generally free from federal taxation, often free from state taxation, and, in the case of U.S. territories like Puerto Rico, also free from alternative minimum taxes (AMT). 

These are tax-free to incentivize people to invest in their communities which by themselves is great! When these bonds trade on the secondary market (buying from someone other than the original issuer of the debt), the bonds can trade for more or less than the original loan amount. If you buy a municipal bond that pays 6% tax-free annually, you will probably pay a premium. Let’s say, hypothetically, it was $110 for a bond maturing in four years at $100 for the high-income level. You would earn 24% tax-free and you would have a $10 loss to write off on your taxes. 

Hold investments into the long term for the capital gains rate. If you hold an investment for more than one year, it will no longer be taxed at ordinary income tax rates. Instead, it will be subject to the lower capital gains rates. When we buy a stock or a bond, we plan to hold it long enough to qualify for long-term capital gains rates.  This is why Mitt Romney’s tax rate was lower than his secretary’s.

Harvest losses. Not every investment does what we expect. When losses occur, we sell to harvest the loss, thus offsetting potential gains in other investments.  Donald Trump sold properties that had losses receiving a deduction and held on to the properties that had appreciation. Property held until death has no taxes unless the estate tax “death tax” limits are reached (for 2019, the limit for an individual is $11.4 million).  To be fair, Trump took chances and lost money which can hurt more than having to pay taxes.

Use index options. When investing, there is a seemingly infinite number of choices. Index options are for sophisticated investors but can be a wise tool for limiting tax liability. 60% of gains are always taxed at long term capital gains rates.

Plan charitable gifts with appreciated assets.  Do you support a church or charity and have an appreciated asset?  Before you give, you may want to donate the appreciated asset to your chosen charity.  You will get a tax deduction and will not have to recognize the gain you obtained in your investment. Almost all charities are set up to receive donations “in-kind.”

Depending on your goals and portfolio, other strategies might be available to help you reduce your tax burden. There’s no reason to be paying more than you need to. Come to our office and talk to a financial advisor to see what tools are already being used and what other strategies might be available to you. 

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