Harvesting Investment Losses for Tax Purposes
October 25, 2011 by Jean Keener, CFP, CRPC, CFDS · Leave a Comment
You frequently hear investment professionals suggest “harvesting losses” before the end of the calendar year to save money on taxes. Loss harvesting can be a highly productive strategy, and it pays to understand how it works and when you might not want to take advantage of it.
The opportunity to harvest losses is available in taxable investment accounts – this includes joint or individual accounts — not IRAs, education savings plans, or employer retirement accounts.
You calculate the gain or loss by subtracting the total purchase price for the investment (including any dividends reinvested) from the proceeds you received from selling the investment. For example, if you purchased a mutual fund for $10,000, reinvested $1,000 in dividends over the years you owned it, and then sold it for $13,000, you would have a tax gain of $2,000. If you sold it for $10,500, you would have a tax loss of $500.
When you sell an investment in a taxable account, you owe taxes on any gain and can deduct any losses against your income on your taxes (up to $3,000 per year). Gains or losses from different investment sales offset against each other to produce a “net” gain or loss. For example, if you have $10,000 in losses and $11,000 in gains, you have a $1,000 net gain. If you have net losses greater than $3,000 in a single year, they can be carried forward to offset gains or be deductible in future years.
Harvesting tax losses can help you offset gains from other investments sold in a given year, and it can result in a deduction on your tax return. Think of the value of a $3,000 deduction — if you’re in the 25% tax bracket, it saves you $750 on your taxes; in the 35% tax bracket, it saves $1,050.
So when wouldn’t you want to pursue this strategy?
- If it’s going to take your asset allocation away from your target. Asset allocation is the biggest factor in investment success. You shouldn’t implement a loss harvesting strategy if it can’t be done without maintaining your target asset allocation. You can usually maintain your target allocation while harvesting losses by purchasing other investments in the same asset class at the same time you sell the loser, but you have to understand and comply with the IRS’s specific wash sale rules to be sure you don’t negate your loss.
- If you’re in the 10% or 15% tax bracket this year and next – you can report long-term capital gains (>1 year holding period) up to the top of the 15% bracket and pay 0% in taxes. If you take losses to offset the gains, you would essentially be “giving” the losses away for free.
There are of course many other situations unique to the individual set of circumstances, so it pays to coordinate your strategy with your tax advisor and financial planner to make sure it’s a win for you.
December Personal Finance Newsletter
December 16, 2010 by Jean Keener, CFP, CRPC, CFDS · Leave a Comment
The December 2010 personal finance newsletter is now available. It includes an important update on social security rules, 2011 IRS mileage rates, considerations in rolling your traditional 401(k) to a Roth IRA, and changes to the adoption assistance program. As always, there’s also an investment market update. Please click here to view the newsletter.
New Health Care Law Highlights
April 2, 2010 by Jean Keener, CFP, CRPC, CFDS · Leave a Comment
If you’re like me, you found it challenging to keep up with the provisions of the health care bills as they worked through the legislative process. But now that the bill is law, it’s helpful to understand how it may affect your individual situation and any changes that need to be made to your financial plan as a result. An overview of some of the most significant provisions:
For individuals
- U.S. citizens and legal residents will be required to have health insurance by 2014, with some exceptions. Those without insurance will face a tax penalty of as much as 2.5% of taxable income.
- Existing employer-sponsored health insurance plans will be allowed to remain essentially the same except the plans will be required to extend dependent coverage to qualifying children through age 26, lifetime limits (and eventually, annual dollar limits) on coverage must be eliminated, waiting periods for coverage cannot extend beyond 90 days, and insurers will not be able to deny coverage or charge higher premiums to people based on their health status and gender.
- Medicaid eligibility will be expanded to include individuals under age 65 whose income is less than 133% of the Federal Poverty Level.
- For families with incomes up to 400% of the Federal Poverty Level, tax credits and subsidies will be available to purchase health insurance through state-run exchanges, and to offset out-of-pocket costs.
- Contributions to a health flexible spending account will be limited to $2,500 per year. Reimbursements from health FSAs and HRAs for over-the-counter drugs will be restricted, and tax-free reimbursements from HSAs and Archer MSAs for over-the-counter drugs will not be allowed, while the tax on HSAs and Archer MSAs increases for distributions not used for qualified medical expenses.
- A rebate of $250 will be available to Medicare Part D (drug coverage) beneficiaries who reach the coverage gap (donut hole) and the coinsurance rate for costs within this gap are gradually reduced to 25%.
- Adults with pre-existing conditions will be able to purchase coverage from temporary high-risk pools until 2014, when coverage cannot otherwise be denied for pre-existing conditions.
- A national program will be established to provide limited reimbursement for long-term care expenses for individuals who participate by contributing to the program’s cost through voluntary payroll deductions.
For employers
- Employers with 50 or more employees that do not offer health insurance coverage will generally have to pay a premium tax of up to $2,000 per full-time employee.
- Employers with more than 200 employees must automatically enroll employees in health insurance plans from which employees may opt out.
- Employers providing health insurance must offer a voucher to qualifying employees to purchase insurance through an exchange.
- Qualifying small employers may receive a tax credit for providing health insurance to employees.
Tax changes
- The threshold for itemized deductions for qualified medical expenses will be increased from 7.5% of adjusted gross income (AGI) to 10% of AGI, though a temporary exception will be maintained for those 65 and older.
- The tax for Medicare Part A (hospitalization coverage) is increased 0.9% for individuals with earnings exceeding $200,000, and for couples with joint earnings greater than $250,000. Also, high-income taxpayers will be subject to a surtax of 3.8% on unearned income, such as capital gains, dividends, annuities, and rental income.
- The law imposes a 10% tax on the amount paid for indoor tanning services.
As provisions go into effect and more details become known, it will be important to update your investments and insurance plans to minimize your tax burden, get the most insurance for your money, and stay in compliance with the law.
March 2010 Newsletter
March 9, 2010 by Jean Keener, CFP, CRPC, CFDS · Leave a Comment
The March 2010 Newsletter is now available. It includes an investment market update, Part II in my series on how to tap into your home equity in retirement, considerations in evaluating an early retirement offer, information on 2009 tax deduction for 2010 Haitian relief contributions, 2011 tax rate proposals found in the federal budget, credit card act provisions, and a reminder on the deadline to take advantage of the home buyers credit. Click here to read it.
June 2009 Newsletter
June 2, 2009 by Jean Keener, CFP, CRPC, CFDS · Leave a Comment
The June 2009 newsletter is now available. It includes articles on the new credit card law provisions, energy-efficient tax credits, estate planning for second marriages, and social security planning. Click here to read it.
The Stimulus Act and You
February 18, 2009 by Jean Keener, CFP, CRPC, CFDS · Leave a Comment
On February 17, 2009, President Obama signed into law the American Recovery and Reinvestment Act of 2009 (the 2009 “Stimulus Act”). The legislation carries a projected cost of $787 billion, and contains hundreds of provisions. Key provisions that may be relevant to you include:
- New Making Work Pay Tax Credit–The Act establishes a new refundable income tax credit for 2009 and 2010 equal to 6.2% of earned income, up to $400 ($800 in the case of a married couple filing jointly); withholding schedules will be adjusted to increase current take-home pay to reflect the credit. The credit is phased out for individuals with modified adjusted gross income exceeding $75,000 ($150,000 for married couples filing jointly).
- Earned Income Tax Credit–The earned income tax credit percentage for families with three or more qualifying children increases from 40% to 45% for 2009 and 2010. The income thresholds at which the credit phases out for married couples filing joint returns also increases for 2009 and 2010.
- Child Tax Credit–For 2009 and 2010, the refundable portion of the child tax credit increases to 15% of earned income in excess of $3,000.
- Hope Credit–For 2009 and 2010, the Hope credit is renamed the American Opportunity Tax Credit, the annual limit per eligible student increases to $2,500 and the credit is now available for the first four years of post-secondary education. Up to 40% of the credit is refundable. The definition of qualified expenses now includes course materials, and the credit can be claimed against alternative minimum tax (AMT) liability. The income levels at which the credit phases out also increase significantly.
- Tax Credit for First-Time Homebuyers–The existing first-time homebuyer credit now applies to qualifying home purchases made before December 1, 2009, and the maximum credit amount is now $8,000 ($4,000 for married individuals filing separately). In addition, the recapture rules (requiring that the credit be paid back) are waived for qualifying homes purchased after December 31, 2008, and before December 1, 2009, provided that the home continues to be the taxpayer’s principal residence for 36 months.
- Deduction for Qualified Motor Vehicles–State sales tax and excise tax related to the purchase of a qualified motor vehicle after February 17, 2009 and before January 1, 2010 can be deducted as part of the deduction for state and local taxes paid on Form 1040, Schedule A, or as part of the standard deduction. The deduction is capped at the tax attributable to a maximum $49,500 purchase price, and is phased out for individuals with modified adjusted gross income exceeding $125,000 ($250,000 for married couples filing joint returns).
- Alternative Minimum Tax (AMT)–2008 temporary AMT provisions are extended to 2009; AMT exemption amounts are increased, and nonrefundable personal credits will continue to offset regular tax liability and alternative minimum tax liability.
| Filing Status | 2008 AMT Exemption Amount | 2009 AMT Exemption Amount |
| Unmarried | $46,200 | $46,700 |
| Married Filing Jointly | $69,950 | $70,950 |
| Married Filing Separately | $34,975 | $35,475 |
- Bonus Depreciation–The additional 50% first-year depreciation deduction applies for an extra year, through 2009 (through 2010 for certain longer-lived and transportation property).
- IRC Section 179 Expensing–The increased limits relating to IRC Section 179 expensing now apply through 2009. As in 2008, the maximum amount that a taxpayer may expense is $250,000 of the cost of qualifying property placed in service for the taxable year. This amount is reduced by the amount by which the cost of qualifying property placed in service during the taxable year exceeds $800,000.
- Net Operating Loss (NOL) Carrybacks–Eligible small businesses (small businesses with average gross receipts of $15 million or less) can elect to extend the existing two-year carryback period for 2008 NOLs to 3, 4, or 5 years.
- Unemployment Compensation–Up to $2,400 of unemployment compensation benefits received in 2009 are excluded from gross income for federal income tax purposes.
- Small Business Stock–The percentage exclusion for qualified small business stock sold by an individual increases from 50% (60% for certain empowerment zone businesses) to 75% for stock issued after February 17, 2009 and before January 1, 2011.
- Economic Recovery Payments–Individuals who are eligible for Social Security benefits, Railroad Retirement benefits, Veteran’s compensation or pension benefits, or Supplemental Security Income (SSI) benefits will generally receive a one-time Economic Recovery Payment of $250.
- COBRA–For involuntary terminations that occur on or after September 1, 2008 and before January 1, 2010, individuals who qualify will only need to pay 35% of COBRA premiums for a period of up to 9 months. The remaining 65% of COBRA premiums will be subsidized. For individuals with adjusted gross income exceeding $125,000 ($250,000 for married individuals filing a joint return), the subsidy must be paid back in part or in full.
Year End Tax Planning Techniques
December 3, 2008 by Jean Keener, CFP, CRPC, CFDS · Leave a Comment
Many tax provisions that had already expired or were scheduled to expire at the end of the year were extended as part of the Emergency Economic Stabilization Act of 2008, signed into law on October 3, 2008. Included in the list of extended provisions is an additional one year alternative minimum tax (AMT) “patch,” eliminating a level of uncertainty that would otherwise have plagued many individuals as they reviewed their year-end tax situation. As always, year-end presents both an opportunity and a challenge when it comes to tax planning. But keep in mind that the window of opportunity for many taxsaving moves closes on December 31.
The basics: timing is everything
Year-end tax planning is as much about the 2009 tax year as it is about the 2008 tax year. There’s a real opportunity for tax savings when you can predict that you’ll be paying taxes at a lower rate in one year than in the other. If that’s the case, some simple year-end moves can pay off in a big way.
Unless you think you’ll be in a higher bracket next year, look for opportunities to defer income to 2009. For example, you may be able to defer a year-end bonus, or delay the collection of business debts, rents, and payments for services. Similarly, you may be able to accelerate deductions into 2008 by paying some deductible expenses such as medical expenses, interest, and state and local taxes before year end.
Delay income / Accelerate deductions
- Delay collection of business debts, rents, and payments for services (if you use the cash method of accounting)
- Defer compensation/year-end bonus if possible
- Defer sale of capital gain property or take installment payments instead of lump-sum payment
- Postpone retirement plan distributions that aren’t required
- Make next year’s charitable contribution this year instead
- Pay medical expenses that are due in January before the end of the year
- Prepay deductible interest and property tax
- Make first quarter installment payment of state estimated tax in December
- Accelerate alimony payments
AMT: What you don’t know could hurt you
If you’re subject to the alternative minimum tax (AMT), traditional year-end maneuvers, like deferring income and accelerating deductions, can actually hurt you. The AMT–essentially a separate federal income tax system with its own rates and rules–effectively disallows a number of itemized deductions, making it a significant consideration when it comes to year-end moves. For example, if you’re subject to the AMT in 2008, prepaying 2009 state and local taxes won’t help your 2008 tax situation, but could hurt your 2009 bottom line.
The Emergency Economic Stabilization Act brought the latest in a long series of temporary “fixes” for AMT, but this patch (which includes increased AMT exemption amounts), expires at the end of the year. It’s likely that a more permanent solution will be implemented next year, but the specifics of such a permanent solution are uncertain.
There’s also good news for many who have been subject to AMT in prior years, particularly those caught in the AMT web as a result of exercising incentive stock options in the past. The Stabilization Act makes the calculation of the AMT refundable credit amount more taxpayer-friendly (through 2012), and eliminates the phase-out of the refundable credit amount for individuals with higher adjusted gross incomes. The Act also provides for an abatement of outstanding tax balances owed as of October 3, 2008, attributable to the AMT treatment of incentive stock options. The bottom line? Consider carefully your AMT situation for 2008 in light of the recent changes.
IRA and retirement plan opportunities
Traditional IRAs (assuming that you qualify to make deductible contributions) and employer-sponsored retirement plans such as 401(k) plans allow you to contribute funds pretax, reducing your 2008 income. Contributions you make to a Roth IRA (assuming that you meet the income requirements) or a Roth 401(k) aren’t deductible, so there’s no tax benefit for 2008, but qualified Roth distributions are completely free from federal income tax–making these retirement savings vehicles very appealing.
For 2008, the maximum amount that you can contribute to a 401(k) plan is $15,500, and you can contribute up to $5,000 to an IRA. If you’re age 50 or older, you can contribute up to $20,500 to a 401(k) and up to $6,000 to an IRA. The window to make 2008 contributions to your 401(k) closes at the end of the year, while you can generally make 2008 contributions to your IRA until April 15, 2009.
For some, it may make sense to think past 2008 and 2009: If you qualify, consider whether it makes sense to convert some or all of your traditional IRA assets to a Roth IRA. Funds that you convert, to the extent that the funds represent investment earnings and deductible contributions, are considered taxable income. Nevertheless, the potential future tax benefit could outweigh the current tax bill.
New and extended provisions
The Emergency Economic Stabilization Act also extended several popular provisions that had expired or were set to expire. To the extent that they apply to you, be sure to factor these items into your year-end analysis:
- For 2008 and 2009, you’ll continue to have the option to deduct state and local general sales tax (instead of state and local income tax) on your Schedule A.
- The above-the-line deduction (maximum $4,000 deduction) for qualified higher education expenses, and the above-the-line deduction for up to $250 of out-of-pocket classroom expenses paid by education professionals, are also extended through 2009.
- Taxpayers age 70½ or older now have through 2009 to make charitable contributions of up to $100,000 directly from an IRA to a qualified charity, without including the distribution in income.
- Beginning this year (and continuing for 2009 as well), individuals who do not itemize deductions are able to claim an additional standard deduction of up to $500 ($1,000 for married couples filing jointly) for real estate property taxes paid.
Energy efficient home improvements
A credit of up to $500 for the purchase of energy efficient home improvements (e.g., insulation, exterior windows and doors) and energy efficient property (e.g., qualified furnaces) expired at the end of 2007.
The Emergency Economic Stabilization Act reinstated the credit, but only for property placed in service during 2009. While limited in scope–for example, the credit is capped at $200 for windows, and $150 for qualified furnaces–the credit offers an opportunity for savings. If you’re eligible for the credit, and plan on making a qualifying improvement or purchase, waiting until 2009 to do so might make sense in order to qualify for the credit.
Tax Credits and Deductions for Higher Education
November 2, 2008 by Jean Keener, CFP, CRPC, CFDS · Leave a Comment
What are the tax credits and deductions relating to higher education?
There are two education tax credits–the Hope credit and the Lifetime Learning credit–that provide some relief to families in the midst of financing their children’s college education. There is also a federal income tax deduction for certain taxpayers who pay qualified higher education expenses, as well as a deduction for certain individuals who pay student loans. As a general rule, a tax credit is a dollar-for-dollar reduction against taxes owed, and it is therefore more valuable than a tax deduction of the same dollar amount.
Hope credit
The first tax credit is called the Hope credit. In 2008, it’s worth a maximum $1,800($1,650 in 2007) per student in tax savings for the first two years of your child’s post-secondary education. The credit is calculated as 100 percent of the first $1,200 of qualified tuition and related expenses, plus 50 percent of the next $1,200 of expenses.
As one would expect, Congress has placed restrictions on the use of the Hope credit. First, the credit applies only to undergraduate students who are enrolled in college on at least a half-time basis. Second, the ability of parents to take the credit depends on their modified adjusted gross income (MAGI). In 2008, for married couples filing jointly, MAGI must be below $96,000 ($94,000 in 2007) to take advantage of the full credit. A limited credit is available to those in the $96,000 to $116,000 range ($94,000 to $114,000 in 2008). For single filers, your MAGI must be below $48,000 ($47,000 in 2007) to take the full credit. A limited credit is available to those in the $48,000 to $58,000 range ($47,000 to $57,000 in 2007).
One distinct advantage of the Hope credit is that there is no limit on the number of credits that may be claimed on a single tax return in a given year (provided each person qualifies independently). For example, if Mom and Dad have triplets who are in their freshman year of college, then Mom and Dad can claim a total of $5,400 ($1,800 x 3) in Hope credits for that year. However, the Hope credit and Lifetime Learning credit are mutually exclusive; they cannot be taken in the same year.
Lifetime Learning credit
The second tax credit is called the Lifetime Learning credit. This credit is worth a maximum yearly tax savings of $2,000. The credit is calculated as 20 percent of the first $10,000 of qualified tuition and related expenses.
As the name implies, the Lifetime Learning credit is intended to apply to higher education courses taken throughout your lifetime, whether to acquire or improve job skills. As such, it is less restrictive on the type and level of enrollment than the Hope credit. For example, the Lifetime Learning credit is available to graduate students as well as to undergraduate students. It is also available to students enrolled on less than a half-time basis. So, a single word processing course taken by a lawyer at his or her local community college will qualify for the credit.
As with the Hope credit, there are restrictions on the Lifetime Learning credit. The same MAGI limits that apply to the Hope credit also apply to the Lifetime Learning credit. One particular disadvantage of the Lifetime Learning credit is that it is limited to a total of $2,000 per tax return per year, regardless of the number of people who qualify in a family in a given year. So, in the example with the triplets, Mom and Dad would be able to take a total credit of $2,000, not $6,000. Yet on the plus side, the Lifetime Learning credit is available for an unlimited number of years, whereas the Hope credit is limited to the first two years of a child’s post-secondary education.
Deduction for qualified higher education expenses
For tax year 2007, you may also be able to deduct at least part of the qualified higher education expenses you paid during the tax year. These expenses include the tuition and fees you’ve paid for enrollment in a degree or certificate program at an accredited post-secondary educational institution. Congress has not passed legislation extending this tax deduction to subsequent years.
Student loan interest deduction
You can deduct up to $2,500 of the interest you pay on qualified student loans each year, provided you meet the income limits. In 2008, for single filers, a full deduction is available with a modified adjusted gross income (MAGI) up to $55,000; a partial deduction is available for a MAGI between $55,000 and $70,000. For joint filers, a full deduction is available with a MAGI up to $115,000; a partial deduction is available with a MAGI between $115,000 and $145,000.
This is a quick overview of education tax credits and should not be considered tax advice for your specific situation.