You may be preoccupied with the upcoming holidays. But another thing you should add to the schedule is year-end tax moves to make your annual encounter with the Internal Revenue Service less painful.
One tax-saving strategy takes on special significance this year because of the stock market’s volatility.
While the recent turmoil in the market may be giving many consumers huge headaches, it does have one sweet spot: It can help you save on your 2000 tax bill.
“A lot of people have taken a lot of gains, and if they have some losers in their portfolio that they’re questioning, they can go ahead and sell those and get them out of the portfolio and offset some of those gains with these losses,” said Terrance S. Eckert, tax and audit manager at Candy & Schonwald LLP, a Dallas accounting firm.
This is what’s called “tax-loss selling.”
Capital losses or investment losses can be used to offset capital gains or investment profits. If the losses exceed the gains, you can use the losses to reduce your taxable income by up to $3,000.
Excess capital losses can be carried into the next year to offset capital gains or income in the future under current tax laws. Losses can be carried forward until they are exhausted or until you die.
But there’s a catch: The tax-loss selling must be completed before Jan. 1.
Investors who believe that the market will come back may think they can sell their losing stocks now, use the losses to offset gains and then repurchase replacement shares to have an investment position in case the stock price comes back.
But if you’re thinking about doing this, be aware of the “wash-sale” rule. Under that rule, you can’t deduct losses from the sale of stock if you buy shares in the same stock from 30 days before the sale to 30 days after.
Here you have two choices: You can cash in your losses and wait 30 days before reinvesting in the stock. The risk there is that the stock’s price may rise during that period and you’d be getting back in at a higher price. Or you could immediately reinvest your money in a similar stock that isn’t considered “substantially identical” to the one sold.
“They don’t want me to sell that stock at a loss to offset my gains, and the next day buy back that same stock I had a loss in,” Eckert said. “If you sold them on one day and bought them back on the next, it wasn’t really an economic loss to you. You’re in the same position you were in the day before. You’re not out any cash.”
The wash-sale rule also applies to mutual funds. You can sell fund shares at a loss and take the loss on your tax return as long as you don’t purchase shares in the same fund within that same time period.
However, you can purchase the shares of a different fund with similar investment objectives and holdings.
For example, if you sold your investment in a bond fund, you could bypass the wash-sale rule by reinvesting in another fund that owned bonds of a similar grade and yield.
Capital losses are most valuable when you use them to offset short-term capital gains — shares held one year or less — or salary that would otherwise be taxed at regular individual income tax rates of up to 39.6 percent.
Investors who trade online would benefit from that, said Charles Enis, associate professor of accounting at Pennsylvania State University in University Park.
“A lot of people who trade online are basically in it for short-term gain,” he said. “These people don’t get any tax advantage from their gains because they’re short-term. They should look for stocks that have losses and sell off enough of those stocks to get $3,000 in losses.”
But be careful not to let tax considerations dominate your overall investment strategy.
“The objective of investing is to make money and not necessarily to save money on taxes,” Enis said.
There are other things that can cut your tax bill.
“Tax planning really concerns the timing and method by which your income is reported and your deductions and credits are claimed,” Enis said. “The basic strategy for year-end tax planning is to schedule your income so it will be taxed at the lowest rate and schedule your deductible expenses so they may be claimed in years when you are in a higher tax bracket.”
Shifting income from one year to another is one way to cut your tax liability. If you expect to be in the same or a higher income tax bracket this year than you do in 2001, defer income until 2001 and shift expenses to 2000 so you can accelerate your deductions to reduce taxes this year.
If you usually get a year-end bonus, ask if your employer can pay you the bonus next year. If you run your own small business and bill your clients, see if you can defer income by not billing until next year.
In contrast, if you expect to be in a lower tax bracket this year than you do in 2001, accelerate income into this year and defer payment of expenses to 2001. Be careful not to shift so much income into this year that you push yourself into a higher tax bracket.
This means that if your employer pays bonuses after the end of the year, ask if you can receive your bonus before the end of this year.
Keep in mind that if you do this, you’d be tinkering with your adjusted gross income, which is a key benchmark for deductions involving traditional IRA contributions, Roth IRA contributions, medical expenses and itemized deductions.
Many tax benefits are phased out for taxpayers with an adjusted gross income above certain levels, so be aware of how changes in your adjusted gross income will affect other items on your return.
If you have a lot of expenses, such as miscellaneous deductions and medical bills, bunch them so that the amount paid this year is above the limit on deducting those expenses.
Have a property tax due in January? Pay it in December to clinch a deduction on your 2000 return.
“This is a wide strategy unless you are subject to the alternative minimum tax this year or will face a higher tax bracket next year,” Enis said.
The alternative minimum tax is a tax system parallel to the regular tax system. Congress created the alternative minimum tax to ensure that the wealthy wouldn’t escape paying at least some income tax by cleverly using tax deductions and credits.
Another way to reduce your tax bill is to consider scheduling elective medical procedures or making charitable contributions before the end of the year.
“Donate, rather than sell appreciated securities,” Mueller said. “If you have appreciated securities that you’ve held more than a year, plus plans to make some charitable donations, keep your cash and donate the stock or mutual fund shares instead. You’ll avoid paying tax on the appreciation but will still be able to deduct the donated property’s full value.”
Finally, don’t forget that you have until April 15, 2001, to contribute to an IRA. A tax-deductible IRA can reduce your adjusted gross income.
You can put up to $2,000 into an IRA if you have that much earned income. But whether you can deduct your contribution depends on whether you’re covered by an employer’s retirement plan and your adjusted gross income.
