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13 November 2013
As an investor, you should focus not on what you make, but what you keep after taxes. Tax-efficient investing has always been a good idea, and because of the new tax to fund the Affordable Care Act, it's more important than ever.
The new tax of 3.8% applies to investments, including capital gains and stock dividends for singles earning over $200,000 and couples earning over $250,000 a year. That's on top of the regular tax you pay on investment income.
The good news is that you can take specific steps right now to limit your tax bill. One is tax-loss selling. Tax-loss selling involves selling losing investments to offset the taxes that you'll owe on your successful investments. I recommend that all of my clients have their portfolio reviewed in November or December to find opportunities to harvest tax losses.
Here's a simplified example of how tax-loss selling can help you keep your tax liability under control in a taxable account. Let's say you sell a stock that you've held for more than a year, and you pocket a capital gain—a profit—of $1,000. That $1,000 is potentially subject to a capital gain tax, of course. However, if you sell another stock to lock in a $1,000 loss, your capital gain, and your tax liability, might be neutralized.
We don't generally sell losers that we feel have an opportunity to turn around and make us money in the foreseeable future, of course. But in many cases, end-of-year tax-loss harvesting is a good reminder to acknowledge that certain investments just don't work out.
Even if you feel that a stock may rebound, you can sell it, reap the loss and then buy it back again after 30 days. In fact, every January there are typically plenty of cast-off stocks and bonds available at newly attractive prices because of tax-loss selling. Savvy investors start the new year off by snapping them up.
Another major way that investors can limit their tax hit is to be investors and not traders. If you hold an investment for less than a year, your capital gains are considered short-term gains, and they're taxed at the investor's highest tax bracket. By holding investments for at least a year, you'll be able to accrue long-term capital gains, which are generally taxed at a lower rate.
The current top rate for high-income earners on short-term capital gains and non-qualified dividends is 43.4%, versus 23.8% on long-term gains. Both those figures include the 3.8% "Obamacare" tax.
Tax-efficient investing can add up over time and have a significant impact on the net performance of your investments. That's why it's a big focus for us at Copeland Wealth Management. We welcome our clients and non-clients to schedule an end-of-year meeting to review opportunities to minimize their taxes, so they can keep more of what they earn.