2016 has been a great year to be a stock market investor. All the major indexes have moved solidly higher, providing profits for short-term traders and long-term investors alike. Dark, bearish fears of the regulatory regime change have been proven wrong as the indexes accelerate on the upside. There is even a chance for the DJIA to break 20,000 before 2017, an unthinkable accomplishment just a few months ago.
Thanks to the monster bull market of 2016, nearly everyone is sitting on substantial profits as the year winds down. I can feel the excitement and anticipation whenever I speak with my fellow investors.
[ad#Google Adsense 336×280-IA] The optimism and positive energy are truly off the charts wherever stock market investors gather.
One thing that I have noticed is that many investors are so excited about their success, they forget about the taxes due by April 15.
Investors of all types still must return a portion of their gains to Uncle Sam come Tax Day.
And some will be shocked at the amount owed!
The good news is that there are several legal ways to mitigate your 2016 federal tax bill.
Before we get started, it is critical to note that I am not a tax expert or an authority of any kind when it comes to investment taxation. ALWAYS be certain to check with a qualified tax advisor about your particular situation before implementing anything suggested in this article.
First, let’s look at short-term capital gains. Investors often mistakenly believe that short-term capital gains taxes only apply to day traders and other short-term market players. Nothing could be further from the truth! Short-term gain taxes are applied to any investment held for less than a year. A year is a long time to hold stocks for anyone other than genuine long-term investors.
Short-term capital gains are taxed at your ordinary federal income tax rate. This means that the more you earn, the more you pay. If you are married, filing jointly, the highest short-term capital gain tax you can expect this year is 39.6%. Remember that short-term capital gain taxes are calculated on your entire income, not just the capital gains. In other words, you need to add the short-term capital gains on top of what you earned from other sources during the year to determine what tax bracket fits.
Perhaps the best way to avoid short-term capital gains is to invest within a tax-deferred account. When your account is structured as a tax-deferred account, you only have to worry about taxes when you withdraw the money.
But that information could be coming too late for some investors. So what can you do if you are just now realizing you will have a massive tax bill in April?
The good news is that there is something that can be done before the January 1, 2017 that will help lower your taxes come April. This tactic is so effective that it has become a standard feature of the new wave of automated investment robo-advisors. The tactic is called tax-loss harvesting.
Tax-loss harvesting is an IRS-approved technique to reduce capital gain taxes owed. Research by Wealthfront reveals that tax-loss harvesting could add over $76,000 to a $100,000 portfolio over the next 20 years.
The way it works is that you sell previously unrecognized investment losses to offset the gains and income. The proceeds of these sales are subsequently reinvested to increase the portfolio value.
There is nothing new about this technique. Advisors to the ultra-wealthy have been using it for decades to help their clients grow wealth and avoid taxes. It is a very simple tactic, but there are several things to keep in mind when implementing it.
First, and perhaps most critically, be aware of wash sale rules. A wash sale is when you buy back the same security, contract, option, or a substantially identical security within 30 days of selling it for tax loss harvesting. The IRS does not permit wash sales when it comes to tax-loss harvesting.
Secondly, make tax-loss harvesting an integral part of your overall investment plan. Although it is ok to divest as late as December 31, it is best not to wait until the last minute to tax-loss harvest. Two or three times per year, re-evaluate your portfolio to cull the underperformers while harvesting losses for tax season, as well as optimizing your portfolio for gains.
Risks To Consider: There are other nuances to tax-loss harvesting not included in this introductory article. Be certain to consult with your tax advisor before instituting any tax-loss harvesting tactic.
Action To Take: Take a close look at your portfolio to determine if you can save on your 2016 tax bill via tax-loss harvesting.
— David Goodboy
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Source: Street Authority