Personal Finance: Year-End Tax Saving Strategies
While staying current with tax law is an ongoing task, there is still time in December to make last-minute decisions to reduce your tax bill next April 16. (Yes, the 16th since the 15th is a Sunday.) This article discusses some year-end tax strategies you may want to consider.
When this article was written, many ideas for changes in tax laws were still floating around Congress. It is unlikely that many will pass this year, and any that do probably will not become effective until 2001.
Estimated TaxesIf you have significant amounts of investment income (or other types of income that are not subject to withholding), you may incur a penalty if you fail to make timely quarterly estimated tax payments. If you failed to have enough withheld or did not make appropriate quarterly payments, you can increase your withholding for the rest of the year. Extra withholding – even late in the year – is treated the same as if it were spread evenly over the year. This action might help you to avoid underpayment penalties. Also, if you're required to pay federal estimated taxes, you may also be required to pay state estimated taxes.
Capital Gains and LossesYou have some control over capital gains and losses; in fact, you can time the sale of securities to produce the best tax results. For example, as year-end approaches you may want to sell shares that have decreased in value to offset other gains. You may select the securities to sell and even choose the particular shares of a stock to sell if you bought shares at different times or different prices. If you sell a portion of a company’s stock or bonds that you purchased at different times and prices, for tax purposes you may designate the particular securities you are selling. Designating those that qualify as long-term capital gains and that you purchased for the highest price will result in minimizing any capital gains tax. Select wisely to minimize the tax bite.
If you sell securities held 12 months or less, gains will be taxed at the rate for ordinary income. Consequently, taking short-term gains can be very costly, especially for those with higher marginal tax rates (up to 39.6 percent). Capital gains enjoyed on securities held for more than 12 months (long-term) will be taxed at 10 percent if you are in the 15 percent marginal tax bracket or 20 percent if you are in the 28 (or above) percent marginal tax brackets. Finally, up to $3,000 of any net capital losses may be deducted each year and net losses exceeding $3,000 may be carried forward indefinitely. State tax laws covering capital losses vary: some states do not permit the deduction of capital losses.
For purposes of determining if you have held an asset 12 months, the holding period starts the day after the day you acquired it. For securities such as stocks and bonds, the holding period begins the day after the trade date, not the settlement date. If you acquired your stock other than by purchase (gift or inheritance) your holding period may relate to some earlier date.
You may have purchased mutual fund shares either directly or through reinvested capital gains or dividends at various prices over a period of years. If you have sold (redeemed) or plan to sell a portion of your shares, the IRS offers four choices for determining their cost. Discuss the choices with your tax advisor. Selection of the appropriate method could result in appreciable tax savings.
Gifting SecuritiesRather than meeting a charitable pledge with cash donations, consider giving the charity appreciated stock or mutual fund shares. Your charitable deduction will be based on the appreciated price (not the purchase price) and you will not have to pay any capital gains tax. To reduce your 2000 tax bill, consider making contributions before yearend. It could be particularly attractive to gift securities now that have appreciated rapidly and, if sold, would be subject to the high short-term capital gains tax.
401(k) PlansMany employers sponsor 401(k) plans. To minimize taxes, contribute the maximum possible to employer-sponsored retirement plans and to any plans that you have established for self-employment income (Keogh Plans). You not only defer taxes on both the amounts contributed to the plan, but you also defer taxes on any income earned thereon. In many cases, you can borrow from the 401(k) plan. The maximum elective deferral to a 401(k) plan for 2000 is $10,500. In many cases it is advantageous to coordinate carefully your contributions to take maximum advantage of a 401(k) and an IRA, such as the Roth IRA.
This article provides general information and should not be relied upon as a source of professional investment or tax advice. Consult your tax advisor to determine those strategies suitable to your situation.