Find the Tax Balance in Your Investment Program

As an investor, you have to juggle a lot, balancing out economic factors with your personal risk tolerance and objectives. And there’s yet another ball to throw into the mix: taxes. Their impact on the bottom line can be significant. Keep your eye on these key points.

- Generally, a sale of securities will result in a capital gain or loss. Gains and losses offset each other on your tax return. Furthermore, any excess net loss can offset up to $3,000 of ordinary income before being carried over to next year.

- The tax law generally provides a maximum tax rate of 15% for qualified dividends and long-term gains on sales of securities held longer than one year. But the maximum tax rate is reduced to 0% for taxpayers in the lowest two ordinary income tax brackets of 10% and 15%. The rate increases to 20% for those in the top that short-term gains are taxed at ordinary income rates.

- Thanks to a recent tax law change, a 3.8% surtax applies to the lesser of “net investment income” (NII) or the excess modified adjusted gross income  (MAGI) above $200,000 for single filers and $250,000 for joint filers. For this purpose, NII includes most income items like dividends and capital gains, but not others such as retirement plan or IRA payouts (although these still increase your MAGI). Thus, the effective federal tax rate on securities sales can range from 0% to 43.4% (39.6% plus 3.8% surtax). How can you tilt taxes in your favor? Consider these five principles of tax advantaged investing.

1. Add investments in tax-free municipals or other tax-exempt obligations. This is especially important to investors facing the combined 43.4% tax rate.

2. Harvest capital losses from securities sales at year-end. Those losses can be especially valuable if they offset short term capital gains.

3. Maximize favorable tax treatment for qualified dividends and long-term capital gains. When it’s available, take advantage of the 0% rate.

4. Manage tax brackets year-to-year. For instance, you might postpone high-taxed gains to next year or accelerate low-taxed gains into this year.

5. Develop a tax-sensitive portfolio. Utilize fundamentals of asset allocation and diversification while taking potential tax implications into account.

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