Planning an advantageous investment strategy that is also tax-efficient can feel daunting initially. Thankfully, there are some things you can do right now to keep from overpaying this upcoming tax season.
Find Your Pro Team
You might need a team for any number of pursuits, from organizing a softball team to putting together people to start a new business. Creating a team is not only finding people to organize, it's also uniting the talents of those people.
Building a financial team to tackle your taxes will frequently 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 more specific, specialized training.
Ask your financial professional if they have worked with a CPA who could be helpful in your particular situation. It’s possible that they know someone who fits your needs perfectly.
Invest With Taxes In Mind
Once you have the right team of financial professionals who understand your financial situation, there are some investment strategies you may consider discussing with them this year.
Backdoor Roth IRA
If you are a high earner, having an income above the IRS’s income limit for Roth IRA accounts, you have the option to create a backdoor Roth IRA. Just like 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, you’ll need to:
- Open and contribute to a traditional IRA.
- Convert your traditional IRA to a Roth IRA account (your account administrator will provide the necessary paperwork and instructions to do this).
- Once tax season rolls around, pay taxes on the contributions (essentially you’re paying back the tax deduction you received when initially contributing to your traditional IRA).
- Pay taxes on any additional gains your traditional IRA account may have made over time.
A backdoor Roth IRA may be beneficial for those people 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 whether a backdoor IRA is for you, evaluate the tax obligations you might pay today versus the tax benefits you may realize toward your retirement.
Making smart moves now can help you manage your taxable income and taxable estate. For instance, if you’ve decided to make 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.
It’s important to realize that this discussion of tax-focused giving is for informational purposes only and is not a replacement for real-life advice. Please make sure to consult your financial, tax, and legal professionals before modifying your gifting strategy.
The annual gift tax exclusion gives you an opportunity to remove assets from your taxable estate. You may give up to $15,000 ($30,000 if you are married) to as many individuals as you wish without paying federal gift tax, provided your total gifts keep you within the lifetime estate and gift tax exemption of $11.7 million for 2021.1 Making sense of the annual gift tax exclusion can involve understanding a complex set of tax rules and regulations. Before adjusting your strategy, consider working with a professional who is more familiar with the rules and regulations.
Tax-loss harvesting refers to the practice of taking capital losses (you sell securities worth less than what you paid for them) to help offset the capital gains you may have recognized in the year. Always 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 a way 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.2 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. Be sure to talk to a tax professional who will be able to answer any questions you have.
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.2
With the above strategies in mind, there are things you may be able to do now to address both your current tax obligation and those you may need to address further down the road.