How We Do Year-End Tax Planning

While the official tax day for 2015 is the fifteenth of April, 2016, most of the smart tax planning moves that could potentially save you thousands have to be done by year end. Once the W-2s, 1099s, and other tax forms are printed, it’s generally too late (with a few exceptions, such as IRA and HSA contributions). That’s why the period between Thanksgiving and Christmas is usually very busy in our office: we are scouring our clients investment accounts and tax documents to see what “low hanging fruit” we can pick before time runs out.

Here are just a few of the strategies we are looking at:

  • Capital Gain Distribution Avoidance — Most mutual funds pay out their capital gains at the end of the year. By doing so, they force the fund owner to recognize at least some of the capital gain on a position before they sell it. Assuming we already want to sell that fund (remember, you never want to let the taxes define your investment thesis), we will consider doing so before the capital gain is paid out. The trick is to find a replacement fund that has already paid its distribution, and more importantly, that we want to own as an investment.
  • Tax Loss Harvesting — Again, assuming that you already want to sell a position, doing so before year end will potentially offset other gains in the portfolio. Capital losses offset capital gains, and then up to $3,000 of ordinary income as well, and any unused losses can be rolled over to subsequent years. For clients especially who are in an unusually high tax bracket this year, tax loss harvesting can have multiple positive effects, including lowering your marginal tax rate, reducing phase-outs, lowering Medicare premiums, and reducing Social Security taxability.
  • IRA Charitable Transfers — Last year, at the very last minute, Congress extended a provision that allows taxpayers over age 70 1/2 to give up to $100,000 to charity directly from their IRAs and the transfer would satisfy their Required Minimum Distribution (RMD). While both writing a check and transferring from an IRA provide a tax break, the IRA transfer also lowers your AGI, which again can have multiple positive side effects, such as increased medical expense deductions, lower taxes on Social Security distributions, and lower Medicare premiums. While Congress has not yet extended this provision for 2015, many experts believe that they most likely will, and if not, you still get the full charitable deduction you would otherwise have gotten.
  • Roth IRA conversions — If you are in a transition year, such as being between jobs, starting a small business, or retired but not yet 70 1/2, it may make sense to convert some of your pre-tax IRA to a Roth IRA. Doing so will potentially increase your taxes for 2015, but the upshot is you move that money into an environment where it can grow tax free “forever.” Depending on the effective tax rate of the conversion, it may make sense to do that in some instances.
All of these moves require careful thought, coordination with your overall financial plan, and planning. But they also have to be done before January 1. This is just one more way a Personal CFO can add value (even in relatively flat investment markets).

Happy tax break hunting!