3 Tax Maneuvers To Execute Before December 31st

The U.S. stock market is up approximately 20% this year. International stocks have done even better. While it's fun to watch our 401(k) balances rise, the after-tax return in our taxable accounts might cause a headache.

REALIZED CAPITAL GAINS

If you rebalanced your portfolio this year, pay attention. When you execute a rebalance in a taxable account, the growth on any appreciated investment you trim is subject to either short term (held < one year) or long term (held > one year) capital gains tax.

In addition to capital gains on both mutual funds and exchange traded funds (ETFs), investors also receive a cumulative annual distribution resulting from a fund's internal stock and bond sell activity (you can't control this, the fund manager does). These internal gains arrive in the form of a dividend at the end of the year.

With the market gaining as much as it has in 2017, investors that rebalanced should prepare for the double whammy of capital gains and a year end dividend, both expected to be larger than normal.

OFFSET YOUR GAINS TO REDUCE YOUR TAX BILL

Capital gains are first offset by capital losses. Unfortunately, almost no asset classes in a portfolio are down right now. Therefore, selling a depreciated investment at a loss isn’t likely before year’s end unless you own a triple leveraged bear market emerging markets fund and you got hammered with a -70% return.

Since you probably don't own something like that, you’ll have to look elsewhere in your 2017 tax return to offset gains with either losses or deductions. Here are three relatively painless ways to accomplish this. You have until December 31st to get it done.

#1 - CONTRIBUTE TO YOUR 401(k)

Or your 403(b), 401(a), or TSP. Contributions to these employer sponsored retirement plans yield the biggest bang for your tax buck. Contributions are a direct offset of taxable income- the thing we’re trying to reduce.

Let’s say you make $100,000/yr. If you signed up for automatic contributions of 10% of your salary, it means your taxable income is now $90,000. Assuming you can afford to throw in a little extra, you could elect to contribute up to an additional $8,000, the total annual contribution cap being $18,000. "Seasoned" investors over age 50 max out at $24,000. Retirement plan elections are usually adjusted online, or just ask your HR department what the process is. Don’t forget to adjust back to what it was come January's payroll.

#2 - PAY YOUR STATE TAX BILL EARLY

If you live in a normal state, you pay state taxes. If you live in Alaska, Florida, Nevada, South Dakota, Texas, Washington or Wyoming (not normal states), move on to #3 since this section doesn't apply to you. If you live in Tennessee or New Hampshire, you’re a maybe so check with a tax advisor.

Usually, taxpayers just wait until they file to pay what their owe in state income taxes. However, if you send in an early estimated state tax payment by December 31st, you get to deduct the amount on your 2017 return. In a year you realize above average capital gains taxes (likely in 2017), the deduction for paying early can reduce your total tax bill. To measure the benefit, try running a tax estimate in TurboTax or just ask a tax advisor.

#3 - DONATE APPRECIATED INVESTMENTS

For investors that write checks to their favorite charity or tithe, most miss a tax-reduction opportunity. When you donate to a non-profit, you get to deduct the donation. Donate prior to year end, and that's another way to chip away at your total tax bill. But, instead of stroking that check, consider donating an appreciated investment instead*. Here’s why the investment donation from a taxable account is more effective than simply writing a check.

Example: you buy a stock for $1,000 and since you’re a genius stock picker it appreciates to $3,000. When you directly donate that $3,000, you not only get to deduct the full $3,000 on your tax return, but you get to forever avoid the $2,000 worth of embedded capital gain as well. It’s a two-for-one bonus!

Ask your financial advisor what paperwork is required to donate appreciated investments, or call your brokerage firm if you don’t have a dedicated financial advisor. Usually, all you need to know is how many shares you want to donate as well as some banking info from the entity you intend to donate to.

DISCLOSURE

Your tax situation is unique. There's no way that everything discussed in this post will work for every reader. Before you execute any of the strategies, make sure you run it by your tax advisor. It's ok, they're not busy in December. So ask!

* Not all charities, foundations, universities, or churches accept donations directly from investments, so ask first.

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