Year-End Investment Tax Planning

The good news, for many people, is that 2014 is shaping up as another positive year for stocks, as of this writing. Stocks have advanced substantially since their low point in early 2009, and many investors are now sitting on large paper gains.

The bad news? The grim tidings haven’t come yet, but many investors fear that they will. Stocks have come crashing down from previous bull markets in early 2000 and late2008—that might happen again in 2015, 2016 or 2017. No one can accurately predict what tomorrow will bring, but many observers see the stock market as overvalued now, likely to fall back.

Thus, investors might want to take some stock gains now, as a precaution against possible future price declines. In fact, some investors already may have taken gains as the market indexes reached record highs.

Taking gains in taxable accounts can trigger income tax, though. As noted previously in this issue in the article, “A Tale of Two Couples,” high income taxpayers could owe 20% on long-term capital gains, plus a 3.8% surtax and any applicable state tax. What’s more, adding to your income might trigger other taxes elsewhere on your return.

Looking for losses

The traditional solution is to take capital losses as well as gains.

Example 1: Counting trades already made this year, trades he’d like to make by year-end and anticipated distributions from his stock funds, Nick Morton expects to have a total of $20,000 in longterm capital gains in 2014. If Nick has $25,000 worth of losses in his portfolio, he could take them by yearend and wind up with a $5,000 net capital loss for the year.

With a net capital loss, Nick would owe no tax on the gains he has taken and plans to take. He could deduct $3,000 of capital losses (the maximum allowed) from his income on his 2014 tax return, cutting his tax bill, and carry over the excess $2,000 capital loss for tax benefits in future years.

That is, Nick could do all this if he has $25,000 of losses in his portfolio. After a lengthy bull market, however, Nick might not have losses to take. Even if Nick had taken huge amounts of losses in 2008–2009, when the market crashed, he might have used them all by now, offsetting gains and deducting losses in the intervening years.

What might Nick do if he has no old losses to use and no opportunity to take new losses? He might donate the stocks he plans to sell to charity (see the article, “Year-End Charitable Tax Planning” later in another post). Nick also might give shares to family members in lower tax brackets (see the article, “Year-End Family Tax Planning,” in another post).

If none of these various strategies are practical for dealing with Nick’s capital gains, he might simply postpone taking any more gains until January 2015. That approach won’t decrease his 2014 tax bill, but it will give Nick a full year to develop strategies to avoid tax on those gains.