This is the last in a series of year-end tax strategies for 2020. The previous 4 have been business related. This article relates to a personal tax reduction strategy.
The basic idea here is to avoid the high taxes (up to 40.8% ) on short-term capital gains and ordinary income. Ideally, you try to lower those taxes to zero, but if you can’t do that, get them down to 23.8% or less by making the profits subject to long-term capital gains.
Put another way: You are paying taxes at a 71.4% higher rate when you pay at 40.8% rather than the tax favored 23.8%.
Some fairly easy adjustments in your portfolio could help significantly reduce your taxes.
The Big Picture
- On your short-term capital gains and ordinary income, you pay federal taxes at rates up to 40.8%. This comes from the top rate of 37% plus the 3.8% ACA tax on net investment income.
- You pay taxes on your long-term capital gains at rates from zero up to 23.8%, depending on your income level.
- You pay taxes on your stock dividends at rates from zero to 23.8%, depending on your income level.
- If your personal capital losses exceed your personal capital gains the tax code limits your capital loss deductions to $3000 and allows you to carry over losses in excess of the $3000 to future years until realized.
- You first offset long-term gains and losses before you offset short-term gains and losses.
NOTE: If you are planning on donating appreciated stock to charity, DO NOT donate stock that would produce a loss.
Here now are 7 basic strategies to achieve the above described goals.
Examine your portfolio for stocks to unload and make sales where you offset short-term gains subject to a high tax rate with long-term losses. Here you are cancelling out the high tax rate gains with low-taxed losses.
Use long-term losses to create the $3000 deduction allowed against ordinary income.
As an individual investor, avoid the wash-sale loss rule.
Under this rule, if you sell a stock or some other security and purchase substantially identical stock or securities within 30 days before or after the date o the sale, you don’t recognize your loss on that sale. Instead, the code makes you add the loss amount to the basis of your new stock.
If you want to use a loss in 2020, you’ll have to sell the stock and sit on your hands for more than 30 days before repurchasing that stock.
If you have lots of capital losses or capital loss carryovers and the $3000 allowance is looking small, sell additional stocks, rental properties and other assets to create offsetting capital gains.
If you sell stocks to purge capital losses, you can immediately repurchase the stock after you sell it as there is no wash-sale ‘gain’ rule.
THIS IS IMPORTANT. Don’t die with large capital loss carryovers-they’ll disappear.
- If your carryover originated from you only, then it all goes away if not used on your joint return in the year of your death
- If your carryover came from joint assets, your surviving spouse gets 50% of the carryover to use going forward.
Do you give money to your parents to assist them with their retirement or living expenses or do the same for for your children (specifically children not subject to the kiddie tax)?
If so, consider giving appreciated stock. If the parents or children are in a lower tax bracket than you, your family will pay less taxes overall if you:
- gift them stock
- have them sell the stock
- have them pay the taxes on the stock at a lower rate than you would have paid
For example, you are going to give your parents $10,000. The gift of $10,000 provides you no tax benefit. But, say you have a stock worth $10,000 that you paid $2000 for. If you gift that stock to your parents, and they sell it, they will pay tax on that sale according to their income level. The tax due on that sale for them would be either 0%, 15% or 20%. At the same time, you avoid capital gains tax on the sale of the asset.
Similarly, you could give a donation of appreciated stock to a charity and realize more tax benefit, in the following manner: Say you donate an appreciated asset with a current fair market value of $10,000. As in the above example, you paid $2,000 for the stock.
- In donating the stock, you deduct the appreciated value of $10,000
- You don’t pay taxes on the gain which would have happened if you sold the stock.
A couple of things to consider:
- Your deductions for donating appreciated stocks to 501(c)(3) organizations are not allowed to exceed 30% of your adjusted gross income.
- If your publicly traded stock donation exceeds the 30%, tax law allows you to carry forward the excess until used up, for up to 5 years.
If you could sell a publicly traded stock at a loss, do not give that loss-deduction stock to a 501(c)(3) charity because if you sell the stock, you have a loss that you can deduct. If you give that stock to a charity, you kiss the loss goodbye and only get the deduction for the reduced value of the donation.
Solution: Sell the stock first, give the cash to charity, deduct the loss on your tax return.
Example: You bought a stock for $10,000 and it is now worth $2000. Do the following:
- Sell the stock
- Collect $2000 in cash on the sale of the stock
- Donate the $2000 to charity
- Deduct the $2000 charitable donation
- Deduct the $8000 stock loss
Either way, the charity gets $2000 but done right, you get $10,000 in deductions.
This is the last of the 5 last minute 2020 year-end tax deduction articles. I hope you found it helpful.
Follow this blog to become aware of more strategies or let AFS prepare a tax plan, either a personal one or a business one. Either way, we can make sure you get the advantage of correctly implemented tax strategies, year after year.
What will you do with that extra cash?
AFS-come see us for your tax needs