We have had over a year to adjust to the tax changes that took effect on Jan. 1, 2013. Most of us have filed our 2013 returns and felt a bit of the pain of those changes. Did you experience the new Medicare tax of 3.8 percent that was applied to your taxable interest, annuities, dividends, rents, royalties, capital gains or passive activity income if your income was above a specific threshold? Did you notice that the top long-term capital gains rate moved from 15 percent up to 20 percent? We are in reactionary mode by the time we put our taxes together and feel the pain, but you can be proactive around a variety of taxation issues. Taxes can make a huge dent in your investment portfolio potential returns in the short-term and over time, but you can be proactive.
I am grateful to pay our share, but I want to be smart about it. Remember there is a difference between tax efficiency or avoidance and the evil brother — evasion!
According to Lipper, Taxes In the Mutual Fund Industry, 2010, mutual fund investors paid approximately $736 million in 2009 due to short-term capital gains, $149 million in long-term capital gains taxes and $12 billion in taxes on dividends.
Brian Langstraat is president of Parametric Portfolio Associates. They help investment managers implement tax management strategies. Brian asserts that while taxes can take an enormous bite out of an investor’s return — you can do something about it. You need to move from the traditional sole use of end of year tax harvesting strategies into making tax efficiencies a year-round component of your investment management process.
Your rate of return has a place, but it is what you put in your pocket to accomplish what is important to you that is paramount. Some of the tools available to investment managers of tax-managed portfolios include:
Tax-lot accounting. This is a method of accounting for a portfolio in which the manager tracks the purchase and sale price and cost basis of each security. This allows a manager to “swap” a batch of stocks with long-term gains for a batch with smaller, short-term gains.
Loss harvesting: The manager holding a stock at a loss sells all or part of it to realize the loss, and then purchases a similar stock (to avoid the wash sale rule) that may help offset some future gain.
Wider rebalancing ranges: This can help reduce the number of trades made to your portfolio within a range of your target allocation, which may lead to lower realized capital gains and the corresponding tax implications.
Gain-loss offset: At year end, you sell securities that have a loss to help offset the gains in securities that have grown in value.
Other strategies include delaying the sale of stocks that are about to enter the “long-term” tax category; identifying the highest cost basis stocks for your charitable intentions; and being strategic in which stocks to sell for those seeking regular income from their portfolios.
Look at the tax efficiency of your portfolio. Determine what short- and long-term strategies best fit into your plan. Know that the world of investing is getting increasingly complex and you need to bring in the professionals when appropriate. It is Springtime in the Rockies and April 15 is behind us. Do not put your tax hat away until next year. You will get year-round and long-term benefits if you become tax-management-minded with your investments.
Danielle Howard is a CERTIFIED FINANCIAL PLANNER ™ practitioner. Wealth By Design, LLC, her financial life planning office is located at 23300 Two Rivers Road in Basalt. She helps clients build financial lives to facilitate their passions and purpose. Visit her at www.wealthbydesign4u.com or call 927-3909. Advisory Services offered through Cambridge Investment Research Advisors, Inc., A Registered Investment Advisor. Securities offered through Cambridge Investment Research, Inc., a Broker/Dealer, Member FINRA/SIPC. Cambridge and WBD are not affiliated.