Preparing a strategy that is both advantageous and tax-efficient might feel daunting at first. Thankfully, there are some things you can do now to keep from overpaying next tax season.
Build Your Team of Professionals
You might build a team for any number of pursuits, from organizing a baseball team to putting together people to run a business. Any team is not only an organization of people, it’s also an compilation of talents.
Building a financial team to tackle your taxes may often mean talking to more than one person. Your trusted financial professional can speak to a wide range of financial issues, but they may want to consult others who have specialized training.
Ask your financial professional if they have worked with a CPA who would be helpful in this situation. It’s possible that they know someone who fits your needs.
Tax-Focused Investment Strategies
Once you have the right team of financial professionals who understand your financial situation, there are some investment strategies you may consider using this year.
Backdoor Roth IRA
If you are a high earner with an income above the IRS’s income limit for Roth IRA accounts, you still have the option to create a backdoor Roth IRA. Just as it sounds, this option allows high earners to bypass the income limits and still utilize the tax advantages of a Roth IRA account.
To create a backdoor Roth IRA, all you’ll need to do is simply:
- Open and contribute to a traditional IRA.
- Convert your traditional IRA to a Roth IRA account (consult your advisor for the necessary paperwork from your custodian).
It is typically best to convert the IRA to Roth as soon as possible for record-keeping purposes. At a minimum, converting in the same tax year will allow both transactions to offset each other, resulting in little or no tax impact for the year. A backdoor Roth IRA may be beneficial for those whose income level is above the ceiling limit set by the IRS. Additionally, it’s important to remember that Roth IRAs do not have required minimum withdrawals, only traditional IRAs do.
When considering a backdoor IRA, evaluate the tax obligations you might pay today versus the tax benefits you may realize toward retirement. Typically, the younger you are, the more the tax-free growth of your investments outweigh the tax benefits you receive today.
Smart moves can help you manage your taxable income and taxable estate. For instance, if you’re making a charitable gift, giving appreciated securities that you have held for at least a year is one choice to consider. In addition to a potential tax deduction for the fair market value of the asset in the year of the donation, the charity may be able to sell the stock later without triggering capital gains.
Another option is to gift highly appreciated securities to kids or grandkids instead of giving cash. If they have little or no income, they can potentially sell the security with little or no tax implication. This can also be a great opportunity to teach them about investing and even how to make a decision whether to sell the stock they currently own or keep it.
Third, a donor-advised fund can be a highly flexible, tax-advantaged way to distribute money to charitable organizations of your choosing. These funds can then be distributed out of the fund to a charitable organization in the same year or in the future. Since the donation is deductible in the year it is made, a common strategy is for those with a high income or capital gain in one tax year to use a donor-advised fund to offset the tax liability for that tax year.
Fourth, for those who have begun taking Required Minimum Distributions, designating part or all of your RMD as a Qualified Charitable Distribution from an IRA or 401k can create an additional tax advantage as this is an "above-the-line" deduction. Since a QCD is deducted from income before the standard deduction, this typically generates a greater tax deduction than simply taking the standard deduction.
This discussion of tax-focused giving is for informational purposes only and is not a replacement for real-life advice, so make sure to consult your financial, tax, and legal professionals before modifying your gifting strategy.
Tax-loss harvesting refers to the practice of taking capital losses (you sell securities worth less than what you first paid for them) to help offset the capital gains you may have recognized. Keep in mind that the return and principal value of securities will fluctuate as market conditions change and past performance is no guarantee of future returns. While this doesn’t get rid of your losses, it can be an approach to manage your tax liability.
Up to $3,000 of capital losses in excess of capital gains can be deducted annually, and any remaining capital losses above that can be carried forward to, potentially, offset capital gains next year.1 But remember, tax rules are constantly changing, and there is no guarantee that the treatment of capital gains and losses will remain the same in the coming years.
By taking losses this year and carrying over the excess losses into the next, you can potentially offset some (or maybe all) of your capital gains next year. Before moving ahead with a trade, it’s important to understand the role each investment plays in your portfolio.
If you’re looking into this strategy, familiarize yourself with the IRS’s “wash-sale rule.” This rule indicates that investors can’t claim a loss on a security if you buy the same or a “substantially identical” security within 30 days before or after the sale.1
With these strategies in mind, there are things you may be able to do now to address both your current tax obligation and those you may be required to address further down the road.
Evergreen Financial Group is a Fee-Only Financial Planning and Investment Firm located in Billings, MT serving clients in Montana, Wyoming and virtually across the country. Evergreen Financial Group specializes in working with Christian families, including Young Professionals, Current and Future Retirees and Church Staff Members.
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