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Take a Tax Season Approach Year Round


Hardly seasonal, tax planning can be an every-month endeavor

Tax day is over!  CPAs can again see their families, take a day off, and be home before 10:00pm.  It seems like only early April and late December are when taxes are top-of-mind.  It is during these times I get more requests about tax savings techniques than the rest of the year combined.  However, the smart investor knows taking a tax-focus to their financial plan and investment strategy all year round is what is going to set them apart from the average investor.

Tax optimization should be a factor in every decision related to your wealth management strategy.  While these savings may not be a number you can see on a year-end statement, by implementing the below tactics, your after-tax return can greatly improve.

Put Your Investments Where They Go:  You likely have a variety of types of accounts. You have retirement plans like IRAs, Roth IRAs, and 401(k) plans. You also have non-retirement accounts.  All these have different tax treatment. You also likely have a variety of investments, like bonds and equities, in these accounts. These too have different tax treatment.

Often, the average investor has their accounts invested very similarly with overlapping investments in each account.  While this seems like a reasonable strategy, executing a strategy like this leaves money on the table.  The smart investor aligns each investment with the most appropriate account type.  For example, we recommend investors put assets they expect to greatly appreciate in taxable accounts, income producing assets in tax-deferred accounts like Traditional IRAs, and the most appreciating assets in Roth IRAs. By doing this, the investor pays the lower capital gains tax rate when they sell appreciated securities in the taxable account and defers paying income tax on the interest and dividends from the assets in the IRA.  Research shows executing this strategy adds anywhere between 0.10% – 0.50% per year to your overall return.  This is free money! You own all the investments already; just put them in the appropriate account to optimize their overall potential.

Donate Smartly: If you are charitably inclined, it is important to donate wisely. For most, it is common practice to simply write a check to your church or charity.  However, if you have a highly appreciated stock in your portfolio it is much more advantageous to you to donate your stock rather than your cash. For example, let’s say you have a stock you purchased for $100 and it is now worth $150. You would like to donate $300 to your favorite charity. Instead of donating cash, you can donate two shares of your stock. You still get the deduction for $300, and the charity still gets $300. However, you have avoided paying the $50/share capital gain on the appreciated stock. That is an additional savings of at least $15 on the donation!

Additionally, if you are expected to have a high-income year (maybe a large bonus, your last year prior to retirement, or before a career change) or anticipate not being able to itemize your tax deductions, it may make sense to front load your charitable donations. You can do this by establishing a donor advised fund. For example, let’s say you typically donate $10,000/year. You can donate $50,000 (of appreciated stock, hopefully!) and take the full $50,000 deduction this year. Over the next five years, you can donate from your donor advised fund your $10,000/year. Again, there is no difference to the charity, but you’ve taken advantage of lowering your income this year when the deduction is particularly valuable to you.

Maximize your Deductible Contributions: Whether you are a small business owner, corporate employee, homemaker, or an under 65-year old retiree, there may be tax-deductible accounts you are eligible to contribute to.  If you have access to an employer sponsored plan, an IRA, or HSA, it is usually a good idea to take advantage of these types of accounts to get a tax deduction today.  Typically, there are contribution rules, so I recommend you talk with your wealth manager and/or accountant to confirm eligibility and ensure you are not missing any potential deductions.

Take Advantage of Market Dips:  Market corrections (a decline of 10% of more) happen on average about once a year.  During these times, the smart investor knows to not panic and waits and weathers the storm. The even smarter investor takes advantage of these dips.  These investors will intentionally sell positions at a loss in their taxable account, lock in the loss for their tax return, and immediately purchase a highly correlated (but not exactly identical!) position to participate in the rebound.  For example, let’s say you invest $100,000 today in a S&P 500 ETF and the position drops 10%, so you have a paper loss of $10,000. By executing a tax loss harvesting strategy, you can sell your position, lock in the $10,000 loss, and purchase a position that is expected to perform extremely similarly to your original position.  Once the market recovers, you participate in the recovery but you now have a $10,000 loss for tax purposes. If you have any other gains for the year, you can offset those gains by the $10,000 loss you banked. If you do not have any losses, you can offset your income by $3,000 and carry forward the remaining $7,000 loss for future years.

Implementing these tactical strategies will add to your overall after-tax return.  As you can see, these are activities you may be already doing: you likely have multiple account types, are donating, and of course, have experienced market volatility.  However, as with anything, there are more efficient ways to execute your strategy.  Therefore, please do not focus on taxes a few days a year, but execute a tax-focused strategy year-round.

This commentary is provided for general information purposes only, should not be construed as investment, tax or legal advice, and does not constitute an attorney/client relationship. Past performance of any market results is no assurance of future performance. The information contained herein has been obtained from sources deemed reliable but is not guaranteed.


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