Tax Tips For The Individual Investor

As the old saying goes, there are only two certainties in life: death and taxes. While we have yet to find a way to successfully avoid either, there are a few tricks of the trade that can minimize the impact the taxman has on your pocketbook.

After all, nobody likes taxes, but we all have to deal with them, so we might as well handle them in the best way possible. When the end of the year approaches, many investors' thoughts turn to how they can avoid paying tax. (Notice we said avoid, not evade.) Although a lot depends on your personal situation, there are a few simple tax principles that apply to most investors and can help you save money (We also recommend talking to a tax planner.) In this article, we'll look at the tax benefits of making smart investment decisions, writing off expenses, effectively managing your capital gains and more.

Are you an investor who ends up paying too much capital gains tax on the sale of your mutual fund shares because you've overlooked dividends that were automatically reinvested in the fund over the years? Reinvested dividends increase your investment in a fund and thus reduce your taxable gain (or increase your capital loss). For example, say you originally invested $5,000 in a mutual fund and had $1,000 in dividends reinvested in additional shares over the years. If you then sold your stake in the fund for $7,500, your taxable gain would be the result of subtracting from the $7,500 both the original $5,000 investment and the $1,000 reinvested dividends. Thus, your taxable gain would be $1,500. Many people would forget to deduct their reinvested dividends and end up paying tax on $2,500.

While the reduction in taxable income in this example may not seem like a big difference, failing to take advantage of this rule could cost you significantly in the long run. By missing out on tax savings today, you lose the compounded growth potential those extra dollars would have earned well into the future, and if you forget to consider reinvested dividends year after year, your tax-adjusted returns will suffer considerably in the long term. Keep accurate records of your reinvested dividends and review the tax rules applicable to your situation every time tax season comes around. Doing this will serve as a reminder of the details you need to use to your advantage again and will hopefully make you aware of new tax avoidance opportunities at your disposal.

When the stock markets perform badly, investors make the flight to quality and look elsewhere for places to put their money. Many find a safe haven in bonds. When you are calculating your taxes, remember to report the interest income on your tax return: you may not have to pay tax on all the interest you received. If you bought the bond in between interest payments (most bonds pay semiannual interest), you usually won't pay tax on interest accrued prior to your purchase. You must still report the entire amount of interest you received, but you'll be able to subtract the accrued amount on a separate line.

Many investors also find short-term government debt a convenient safe harbor for their money when the equity markets are less than robust. Municipal bonds are often issued by local governments or similar entities in order to finance a particular project, such as the construction of a school or a hospital, or to meet specific operating expenses. For the retail investor, municipal bonds, or munis, can offer significant tax advantages. Most munis are issued with tax-exempt status, meaning the returns they generate do not need to be claimed when you file your tax return. Combined with the added safety of the low-risk nature of municipal bonds, they can be very attractive investments when stock market expectations are weak. (For further reading, see Weighing the Tax Benefits of Municipal Securities.)

Did you buy a home computer last year? If you did, you can possibly write off a portion of the cost if you used the computer to place trades or to help manage your portfolio. The portion of the computer's cost that is deductible depends on how much you use the computer to monitor your investments. For example, if you paid $1,500 for a computer, and you use it to keep tabs on your investments 20% of the time, $300 of the computer's cost is eligible to be written off as an expense.

For investors who invest in small business ventures or are self-employed, there are many operating expenses that can be written off. For example, if you take any business trips during the year that require you to obtain accommodations, the cost of your lodging and meals can be written off as a business expense, within specified limits dependent upon where you travel. If you travel frequently, forgetting to include these types of seemingly personal expenses can cost you sizeable dollars in lost tax savings.

For homeowners who have moved and sold their home during the year, an important consideration when reporting the capital gain on the sale is the actual cost basis of the purchase of the home. If your home has undergone renovations or similar improvements having a useful life of more than one year, you will likely be able to include the cost of such improvements into the adjusted cost base of your home, thus reducing your capital gain incurred on the sale and the resultant taxes.

Tax-Deferred Programs Are Like Free Money
Every time you trade a stock, you are vulnerable to capital gains tax. Making your purchases through a tax-deferred account can save you a pile of money. Tax-deferred accounts come in many shapes and sizes. The most well known are Individual Retirement Account (IRA) and Simplified Employment Pension (SEP) plans. The basic idea is that you are not taxed on the funds until you withdraw, at which point you are taxed at the rate of your income tax bracket. Waiting to cash in until after you retire will save you even more because your income will likely be lower when you are no longer working and earning a steady income.

Also, while the benefits of tax-deferred accounts are substantial on their own, they provide an additional benefit of flexibility, as investors need not be concerned with the usual tax implications when making trade decisions. Provided you keep your funds inside the tax-deferred account, you have the freedom to close out of positions early if they have experienced strong price appreciation, without regard to the higher tax rate applied to short-term capital gains.

Match Your Profits and Losses in the Same Year
In many cases, it is a good idea to match the sale of a profitable investment with the sale of a losing one within the same year. Capital losses can be used against capital gains, and short-term losses can be deducted from short-term gains. Also, if you have a particularly bad year, you can carry $3,000 of your loss over to future years. This may seem like a counterintuitive method, but it works very well in reality. The key is that capital gains (or losses) are only applied to your tax return when they are realized. So-called paper gains and losses do not count - since you have not actually sold your investments, there is no guarantee that your investments will not change in value before you close out your position. However, by actively choosing to close out (perhaps temporarily) of losing investments, you can successfully match your capital gains with offsetting losses, significantly reducing your tax burden. (Learn more about tax-loss harvesting in Selling Losing Securities for a Tax Advantage.)

Add Broker Fees to the Cost of Your Stocks
Buying stocks isn't free. You always pay commissions and may also pay transferring fees if you change brokerages. These expenses should be added to the amount you paid for a stock when determining your cost basis. When you sell the shares, subtract the commission from the sale price of the stocks. Think of these costs as a write-off because they are direct expenses incurred to help you make your money grow.

Qualities of a Leader

How often have you heard the comment, He or she is a born leader? There are certain characteristics found in some people that seem to naturally put them in a position where theyre looked up to as a leader.

Read More

Secure Client Portal

Forgot password?

Sign up For Our Newsletter

Get Weekly Tax & Wealth Building Tips!