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How Year-End Decisions Can Directly Impact Your Savings and Minimize the Amount of Taxes You Owe

2020 has been as unconventional a year as we can remember, and your tax situation may be different than in previous years. As we enter into the fourth quarter, now is a great time to implement certain year-end tax planning moves prior to December 31. Whether you’ve had a banner year or are looking forward to putting this one in the rear-view mirror, these six year-end tips can directly impact your savings and minimize the amount of taxes you owe.

Tip #1 – Finalize charitable donations

Take some time to evaluate your charitable commitments for the rest of the year. While charitable donations by check or cash are the most common, you may also consider utilizing low-cost-basis stocks for larger charitable contributions. If you plan to itemize, you can receive a tax deduction based on the fair market value as of the date of the gift, and both you and the charity can avoid paying taxes on the gain. This is applicable to investments that have been held for at least 12 months.

If you do not itemize, it may make sense to combine two or three years of charitable contributions that you would normally make over multiple years into a single tax year. The strategy of consolidating your gifts into one tax year is called bunching. The bunching technique can benefit donors whose itemized deductions fall below the standard deduction ($24,800 for married filing jointly, $12,400 for single filers, in 2020) as long as there is sufficient taxable income to fully deduct. In a tax year during which combined gifts are made using the bunching strategy, you can use a charitable vehicle, such as a donor-advised fund (DAF), in order to receive an immediate tax deduction through itemizing federal deductions. You would then be able to recommend grands from the DAF to qualified charities using the standard deduction in subsequent years.

To receive credit for the 2020 tax year, these transactions would need to be completed by December 31, 2020.

Tip #2 – Actively harvest losses to offset gains

Tax-loss harvesting works by taking advantage of selling assets that have declined in value in the short term, a common occurrence in a heavily weighted equity portfolio, and replacing the investment with a highly correlated alternative investment. If done correctly, the result is that the risk profile and expected return of a portfolio remain unchanged, but the temporary tax losses are extracted in the transaction. By realizing the investment loss, a tax deduction is generated that can lower your taxes. These tax savings can then be reinvested to further grow the value of your portfolio.

This ongoing trading strategy allows the long-term investor to stay invested in the space, weather the short-term asset class pullback and transfer the loss to his or her tax return. Losses can be used to offset ordinary income taxes at $3,000 per year, current year capital gains (unlimited), or can be carried forward until utilized against future income or gains.

Given the tremendous market swings we saw in early 2020, it is an important year