It’s time for investors to do year-end tax planning. These steps can minimize 2019 taxes on your personal income, investment income and capital gains.
Some of these tax-saving tips apply to familiar, long-standing tax rules. Other tax planning steps are possible because of changes in tax rules.
All of these tax planning tactics are easily doable with a month and a half left in the calendar year. All apply specifically to investors.
Tax Planning For Capital Gains
If you are a married joint filing taxpayer and your taxable income is below $78,750, you pay zero tax on capital gains held more than one year. For single filers, the threshold is $39,375.
“Let’s say you have $50,000 in taxable income, and you are a married joint filer,” said Brian Ellenbecker, a senior financial planner at R.W. Baird’s Private Wealth Management Group. “You can realize up to $28,750 in capital gains, and the capital gains will be taxed at zero.”
If you exceed certain income levels, your long-term gains will be subject to at least a 15% tax rate.
Married joint filers with 2019 taxable income above $488,850 will get hit with the top cap gains tax rate of 20%. The 20% rate applies to singles with taxable income over $434,550 in 2019.
In your tax planning, remember: Short-term cap gains are taxed at ordinary income rates of 10% to 37%. If you sell an investment you owned a year or less, you have a short-term capital gain.
What’s the difference between taxable income, adjusted gross income and modified adjusted gross income? See lower in this report.
Tax Planning For The 3.8% Surtax
Investors with a lot of investment income get hit with an additional 3.8% surtax on net investment income.
This levy falls on married-joint filing investors whose 2019 modified adjusted gross income is above $250,000. It hits single filers whose MAGI is higher than $200,000.
In your tax planning, remember that the types of income that can put your MAGI above the thresholds include salary, investment income, dividends, IRA and 401(k) withdrawals, pension income and any taxable portion of your Social Security benefits, Ellenbecker says.
“So if a married couple earns (MAGI of) $225,000, they can realize capital gain (and other investment income) of $25,000 before being assessed any additional tax in the form of the investment income surtax,” Ellenbecker said.
He added, “If that same couple realized a capital gain of, say, $30,000, the $5,000 above the threshold would be assessed the 3.8% surtax.”
Roth Conversion Recharacterization
One thing that makes 2019 tax planning a little harder is the Trump tax reform, whose official name is the 2017 Tax Cuts & Jobs Act (TCJA). It eliminated one of the most popular legal tax loopholes. That was the right to recharacterize, or undo, a Roth conversion.
Before, you could reverse the conversion of traditional IRA money into a Roth IRA if you changed your mind.
Taxpayers used that option if the value of the assets they converted had fallen a lot since then. Why? So they would not have to pay income tax on the amount converted, which had become worth much less since then.
The recharacterization gave those investors an opportunity to do another conversion at the lowered value, paying less tax the second time around because the sum converted was now worth less.
Ellenbecker said, “A Roth conversion can still be a great idea. You have to make sure it still fits your situation.”
Tax Planning For Use Of Capital Losses
It has been a year of ups and downs in the stock market. If some of your securities have unrealized losses, you can harvest them to offset taxable gains.
Remember that you must use short-term losses to offset short-term gains first, then long-term losses to offset long-term gains. That’s a good thing because short-term gains are taxed at ordinary income rates, which are usually higher than the rates that apply to long-term gains.
Better yet, if your total losses exceed total gains, you can offset up to $3,000 of other income that year with the excess loss.
And losses in excess of that $3,000 can be carried forward to offset your gains in some future year.
But keep your priorities straight. “Investment decisions should trump any tax considerations,” Ellenbecker said. In other words, don’t dump an otherwise good investment just to create a tax loss to offset yet other gains — unless it makes strategic sense from an investment standpoint.
Difference Between Taxable Income, AGI And MAGI
Of course, as your taxable income rises, your marginal tax rate and bracket climb to higher plateaus. And different tax planning rules can apply to taxable income, adjusted gross income (AGI) and modified adjusted gross income (MAGI). How do those types of income differ?
Your gross income is the total of your earnings and income.
When that income is adjusted for deductions like alimony payments and contributions to a traditional IRA, you’re left with adjusted gross income. If you subtract either the standard or itemized deductions as well as any qualified business income deduction, if applicable, from AGI, you get your taxable income.
MAGI is what AGI becomes if you add back certain items such as foreign earned income and tax-exempt interest.
The IRS uses MAGI to determine whether you’re eligible for certain deductions, and how much of them.
Follow Paul Katzeff on Twitter at @IBD_PKatzeff for tips about personal finance and active mutual fund managers who outperform the market by picking top-performing growth stocks.
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