Tax Planning: Now’s the Time to Tackle It!

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Year-end is still months away, but smart investors have already begun their tax planning. Spending time analyzing your capital-gain situation could benefit you come next April 15th, no matter what investment vehicles you use - individual securities, mutual funds, exchange traded funds, or others. Here's how…

With last December's passage of the Tax Cuts and Jobs Act, your 2018 tax picture may have changed. But whether it's better, worse, or relatively the same, no one wants to pay more in taxes than necessary. Now is the time to review your personal tax situation to understand your planning options.

Be Strategic about Capital Gains

The primary way investors realize capital gains is by selling a security. While you can often choose to hold appreciated securities to avoid capital gains, this isn’t always possible or wise. If you’re considering selling an appreciated security, consider ways to offset the gains. The easiest one: realizing capital losses. Look for securities in your portfolio with unrealized losses and sell those to minimize, or even completely offset, the realized gains.

Contribute to Charities

Another strategy for offsetting capital gains is to gift your appreciated assets directly to a favorite charity. This is a twofer! You won't owe any capital gain tax, plus you'll receive a charitable tax deduction based on the fair market value of the asset at the time of your donation.

You can also create a charitable vehicle and contribute appreciated securities to it.  Examples include donor-advised funds, charitable remainder trusts, and charitable lead trusts. Once in the charitable account, the donated stocks or mutual fund units can be sold, and you won't pay any capital gain tax. You'll receive a charitable tax deduction for the fair market value of the securities in the year of your contribution to your charitable vehicle.

One big caveat to think about for both these strategies: With the increase in the standard deduction and the limitations or elimination of previously allowable itemized deductions, fewer taxpayers will itemize this year. You could be one of them. If you aren't itemizing, donating appreciated securities is less attractive from a tax-reduction point of view. You'll still avoid the capital gains hit, but you’ll lose the charitable tax deduction benefit. As we’ve discussed previously, you may want to consider lumping two or more years' worth of contributions into one tax year to realize the benefit of itemizing.

Gift to Family Members

In 2018, you can gift up to $15,000 to as many persons as you would like without consideration of gift tax. Historically, taxpayers in a high tax bracket would gift securities to their children or grandchildren who were in a lower tax bracket. While family members kept the same cost basis, any capital gains realized upon sale were taxed at their lower rates.

The TCJA, however, recently adjusted the so-called kiddie tax. Now, the first $2,600 in capital gains remains tax-free, but additional income is taxed based on Estate and Trust tax rates. This means that children will pay 15 percent capital gains tax on gains from $2,601 to $12,700 and 20 percent on gains over $12,701. Depending on your situation, this may make gifting to family members less beneficial.

Watch Out for Mutual Fund Distributions

Capital gain distributions come mainly from mutual funds, though ETFs can distribute them as well. Each year mutual funds/ETFs are required to distribute any net capital gains created by the sale of securities within the fund to its unit owners. The owner must pay tax on this capital gain at the time of distribution, even if the mutual fund units were newly purchased and he or she has received no benefit. These distributions usually occur in the months of November and December.

If you plan to purchase units of a mutual fund during the fourth quarter, research the fund to determine if it's likely to make a sizable capital gain distribution this year. Check out the fund family's website, as most companies post estimated distribution numbers. If the anticipated distribution is large, consider buying the fund after the distribution period to avoid paying an immediate tax on your principal investment.

Summary

We all enjoy profiting from our investment gains. As taxpayers, we have the opportunity to consider various strategies to reduce the tax impact and allow us to retain as much of those gains as possible. Review your investment portfolio and your gifting goals prior to year-end. And, if appropriate, consider incorporating one of the strategies mentioned above. If you have any questions, seek the counsel of a qualified financial advisor or tax professional. Come tax time, you’ll be glad you did!

David Crossman, CFA, is a Senior Portfolio Manager with Bedel Financial Consulting Inc., a wealth management firm located in Indianapolis. For more information, visit their website at bedelfinancial.com or email David.

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