The tax code can be a dizzying place for investors, fraught with tax traps set to trip up the everyday investor. Here are a few of the most common tax mistakes we see ordinary investors making:
- Capturing short-term gains – Realized gains on stocks/bonds held more than a year get better tax treatment. Long-term capital gains rates are significantly lower than short-term rates. Therefore, holding a security an extra day, week or month can sometimes significantly reduce the tax burden. How much you can save? That depends on your tax bracket. For example, an investor in a 15% marginal bracket would pay 0% on long-term gains, those in a 25% bracket would pay 15% on long-term gains, and someone in the highest tax bracket (39.6%) would pay 23.8% on capital gains.
- Failing to consider a Roth IRA conversion – When life gives you lemons… consider a Roth IRA conversion. Any time you convert from a traditional IRA to a Roth IRA, tax is due on that money. If you are in a high tax bracket that year, it’s not usually worth it. However, if for whatever reason, you will have low income in a year, this is an ideal time to convert and settle the tax bill on this money at a significantly lower rate than is otherwise expected in the future. We’ve even recommended and seen clients convert IRAs at a 0% tax rate!
- Not tracking your cost in a non-deductible IRA – If you contributed to an IRA, but did not get a tax deduction because your AGI was too high, you made a non-deductible IRA contribution. That is perfectly legal (though not usually advisable); however, once the deed is done, it is up to you to track those contributions going forward. Why? Because when you withdrawal money from your IRA in retirement, you don’t want to pay taxes twice on that money. A good CPA will track this info on your tax return, but just remember if you switch CPAs or start filing your own returns, that you need to keep tracking that information each year.
- Failing to realize capital gains – Once again, low income in a given year can provide an opportunity to save taxes. Long-term capital gain tax rates for those with taxable incomes under $72,500 (joint filers) are zero percent! (Remember, taxable income is after your deductions are taken out.)
- Gold/Silver in a taxable account – Gold and silver are treated as collectibles and therefore are not eligible for capital gains treatment. The federal tax for long-term gains on collectibles is 28%. Holding these investments in tax-deferred vehicles like IRAs is usually a better strategy. Whether you should invest in gold at all is a question for a different article!
These are all strategies we are constantly looking to take advantage of for our clients. Are you?