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2020 Tax Planning: Keep Taxes to a Minimum on the Investments in your Taxable Accounts

2020 Tax Planning: Keep Taxes to a Minimum on the Investments in your Taxable Accounts

December 10, 2020

There is still time to potentially reduce your 2020 federal income taxes, but you'll need to act soon. There are several tax minimization strategies for individuals including timing your income and deductions, making the most of your retirement and health savings accounts, being smart about charitable donations, keeping taxes to a minimum on the investments in your taxable accounts, and minimizing taxes on your estate and inherited retirement accounts. Many of these strategies need to be completed by the end of the year to be effective, and not all of the strategies may be appropriate for you. Let’s review how to keep taxes to a minimum on the investments in your taxable accounts.

Harvest investment losses to help lower your tax bill

One way to reduce the taxes on your capital gains and ordinary income is to sell some investments that have decreased in value since you bought them.

When you sell stock, mutual fund, or other security in a taxable account at a loss, you can use that loss on your tax return to reduce the capital gains and up to $3,000 ($1,500 if married filing separately) of the ordinary income you must pay taxes on. And if you loss is not fully used on this year’s tax return, the unused portion of it can be carried forward and used in future years.

This strategy is commonly known as tax-loss harvesting. Here’s a simplified example of how it works.

Let’s say that you sell Stock A at a $10,000 profit this year and Stock B at an $8,000 loss. You can use the $8,000 loss on your tax return to reduce the $10,000 capital gain so that you only have to pay tax on $2,000 of it.

Let’s also take a look at what might happen if you loss was $2,500 instead of $8,000. In this scenario, the loss totally offsets the $10,000 capital gain so that you do now owe any tax on the gain. Plus, $3,000 of the remaining $15,000 loss can be deducted from your ordinary income, which lowers you taxes for the year even more. At this point, you still haven’t used all of the loss and can use the remaining $12,000 in future years to reduce the capital gains and ordinary income you must pay taxes on.

When harvesting tax losses, be careful not to buy a substantially identical security within 30 days before or after the sale. If you do, you will have what is known as a wash sale and cannot deduct the loss on this year’s tax return.

Give appreciated securities to family members who are eligible for a lower tax rate

Do you normally give cash to family members? If they are eligible for a lower tax rate on capital gains than you are, you may want to give them appreciated securities to sell rather than selling the securities yourself and giving them the cash. But be sure to consider the kiddie tax before using this strategy.

NEW: The Kidding Tax is Once Again Based on the Parent’s Tax Rate 

If you young child’s interest, dividends, capital gains and other unearned income exceed $2,200 this year, the excess will generally be taxed at your tax rate.

This method of taxing children’s unearned income is known as the kiddie tax and generally applies to the unearned income of children under age 19, or age 24 if a full-time student, that exceeds the $2,200 threshold.

The rules governing the kiddie tax have changed a few times in recent years. Prior to 2018, unearned income above the threshold amount was taxed at the parent’s tax rate. Beginning in 2018, it was taxed at rates that apply to estates and trusts. In 2019, Congress decided to switch back to the parent’s tax rate and gave families the option to use either the parent’s tax rate or the estate and trust tax rate for 2018 and 2019. Beginning in 2020, the kiddie tax is once again based solely on the parent’s tax rate.

Be sure to consider the kiddie tax before giving securities to your younger children. Of course, once your child reaches age 19, or age 24 if a full-time student, all of his or her unearned income will be taxed at his or her own tax rate, which may be considerably lower than yours.

If you have any questions about tax-loss harvesting or giving appreciated securities to your family members, please contact us.