Paul Tarins, RICP®,WMCP®,CSRIC™
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 this 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 amalgamation 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, 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 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.
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.
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.
The annual gift tax exclusion gives you a way 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, so long as your total gifts keep you within the lifetime estate and gift tax exemption of $11.7 million for 2021.1 Managing through the annual gift tax exclusion can involve a complex set of tax rules and regulations. Before adjusting your strategy, consider working with a professional who is 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 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.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.
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 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.
Paul Tarins is an investment adviser representative of and offers investment and advisory services through Portfolio Medics, a registered investment adviser. Nothing contained herein should be construed as a solicitation for investment advisory services. Sovereign Retirement Solutions and Portfolio Medics are not affiliated.