Tax season is upon us and if you have investments that means you'll probably need to pay some kind of state or federal tax on them. We asked local investment advisors David Mozoleski and Jason Cerniglia for some tips on what kinds of investments are taxed and how to mitigate your exposure.
Q. What kind of taxes do you pay on investments?
Jason: For Non-Qualified (non-IRA and non-ROTH) one could potentially pay taxes on dividends, interest and income from money markets, bonds and CDs, as well as potential capital gains. Annuities owned in a non-IRA would have distributed gains taxed as income. In IRA accounts and retirement plans (401k, 403b, 457 plans, etc) distributions are taxed as income, generally. In Roth IRA accounts, growth and distributions are, generally, tax free. Finally, one should be aware of potential taxes (or the avoidance of those taxes) through a step up in basis estate planning strategy.
David: Almost everything you own and use for investment and personal purposes is a capital asset. For example, if you own shares in Company X, those shares are capital assets. When selling those shares, you will incur a gain or a loss. And, depending upon how long you held that asset, you will incur a long- term or short term- gain/loss. A capital gain or loss is short term if you held the capital asset for one year or less. Short-term gains are taxed at ordinary income tax rates and long-term capital gains are taxed at preferential lower rates. The current capital gain rates are 0, 15, and 20 percent. You should consult your tax professional for your rate status.
Q. Are there tax-free investments?
Jason: Yes, there are some investments that can grow tax-deferred and tax free. Annuity investments placed in a non-qualified account can generally grow tax deferred. Gains on annuities are typically taxed (as income) upon distribution from the annuity. Municipal bonds in non-IRA accounts can be federally tax free and, sometimes, state tax free. There are also other types of fixed income instruments that could offer tax rebates or tax free growth opportunities at the state and/or federal level.
David: Tax-exempt bonds are a popular choice for investors looking to minimize their federal and state income tax bills. Tax-exempt bonds are typically called municipal bonds. The bond (debt security) is issued by local, county and state governments. This debt is basically a loan between you, the investor, and the corresponding municipality. The debt issuer agrees to pay you, the investor, a rate of interest in exchange for your capital investment in the municipality. Interest income is tax free, but if you sell the municipal bond at a profit, the investor will have a capital gain to declare on that bond investment. Check with your investment professional to make an informed decision about tax-exempt investments and knowing how to calculate a bond’s taxable equivalent yield.
Q. Are there investment write-offs at tax time?
Jason: There are some additional potential write offs but the most used is that one can write off up to $3000 in non-Qualified capital losses against earned income. Any losses above $3000 can be used to offset capital gains (in perpetuity and until used)
David: An investor can use a capital loss to offset ordinary income up to $3000 per year if you don’t have capital gains to offset the loss. An investor can take a total capital loss on a stock if you own stock that has become worthless because the company went bankrupt and was liquidated.
Q. What are some of the most common ways to minimize investment taxes?
Jason: Avoiding taxes entirely is quite difficult. Dividends, even if reinvested, are taxed regardless of whether one takes the dollars or reinvests them (for example). Understanding a client’s risk profile, investment timeline, and tax bracket can allow an Advisor to provide sound guidance on a path to minimize taxes.
David: Your prior year-end planning is the ideal time to minimize investment taxes. Example strategies include: 1) Harvesting your losses by selling investments that may have unrealized losses to offset those losses against other gains. 2) Harvesting gains if you have capital loss carryovers from prior tax years. 3) Maximizing contributions to either company- sponsored or personal IRAs to take advantage of tax-deferred growth. 4) Use appreciated stock rather than cash when contributing to charities. Please check your tax professional for all tax savings strategies.
Jason Cerniglia
Ameriprise Financial Services/Coastal Wealth Management
Mystic:
56 Williams Ave.
860-245-0251
Glastonbury:
628 Hebron Ave., Ste. 301
860-430-1780
Online: Ameripriseadvisors.com
David Mozeleski
RBC/MC Wealth Solutions Group
200 Glastonbury Blvd. Suite 103
Office: 860-657-1760
Cell: 860-256-1785
Online: us.rbcwm.com/mcwsg