Assuming you have been keeping your investment records more or less up to date, one of the least time-consuming but most profitable tasks you can tackle during the holiday season is basic tax planning.  This column deals with three topics on personal income tax planning in an effort to reduce what you may owe Uncle Sam this coming April.

Individual securities

Determine to what extent you are able to offset realized capital gains with capital losses in your portfolio. However, keep in mind that your portfolio may have few losers, as the last bear market ended during the latter part of the first quarter in 2009. First, compile your realized gains thus far year-to-date.   Then, examine your current portfolio holdings to determine what the current market value of each individual security is relative to your cost, adjusting for any prior sales, stocks dividends or splits. Lastly, look for any investments that are currently below your adjusted cost basis and consider these for sale, hopefully offsetting gains you have harvested previously that year. Keep in mind that this exercise would pertain solely to shares held in non-qualified taxable accounts (not an IRA or pension plan). Investors who sell these shares would claim the gain or loss on Schedule D of Federal Filing Form 1040.

Note the following important IRS regulation on capital gains and losses.  If when comparing your realized (those securities sold or where the company has been purchased for cash by another company) gain with your realized loss, the net result is a loss, only up to $3,000 can be deducted from ordinary income. The balance can be carried forward, indefinitely.

An additional component to consider prior to realizing a capital gain or loss in your portfolio is whether the transaction would trigger a long-term versus short-term capital gain/loss.  Long-term transactions are defined as those in which the underlying security has been held for one year or longer and are generally taxed at 0% for those taxpayers who file jointly with taxable income of $74,900 or less; at 15% percent for those with taxable income between $74,900 and $464,850; and at 20% for those fortunate enough to have taxable incomes above $464,850.  Short-term transactions (those which the security has been held for less than one year) are taxed as ordinary income and subject to the same tax rate as your wages or dividend income.  For most taxpayers, the rate is between 25% and 33% for the federal government.  In both instances, for taxpayers in New York State, long-term and short-term capital gains are taxed as ordinary income.

One final consideration prior to executing a stock or bond trade for tax purposes would be to determine if, by executing this trade, a wash sale would result. A wash sale exists when the transaction results in a loss and a “substantially identical security” is purchased within 30 days.  If this should occur, the tax loss created by the sale would not be deductible. Note that should the wash sale result in a gain, the gain is taxable.

As an aside, never forget that it is always prudent to consider the impact of selling a stock upon your portfolio.  Simply put, it is seldom wise to make a transaction solely for the purpose of saving money on your tax return!

Mutual funds shareholders

Another area where individuals may save tax dollars pertains to mutual funds. To determine how beneficial this might be you must first contact the shareholder service department of the mutual fund to determine if it is planning any year-end distributions. Keep in mind that capital gains declared by mutual funds are taxable regardless of whether you receive them in cash or reinvest in additional shares.  Furthermore, there is no economic benefit to the distribution. It is the same as getting four taxable quarters in return for your non-taxable one dollar bill. Upon calling, should you learn that your mutual fund is intending to declare a capital gain, find out how much it will be on a per-share basis and on what date it will be declared. This information will help you determine what steps, if any, need to be taken to minimize the impact of this declared gain.

After gathering this data and adding any year-to-date or pending dividend and capital gain distributions to your basis, should you have an unrealized loss, consider swapping this fund in which you have a taxable loss for a similar fund.  Note that your adjusted tax basis consists of your initial contribution to the fund plus any subsequent out-of-pocket contributions as well as any reinvested dividends or capital gains declared during prior calendar years, less any withdrawals. Regardless of what others might say to the contrary, given the fact that there are over 8,000 mutual funds to choose from, there is always an appropriate alternative to your current fund. Do not think that your fund is “the best” or “one of a kind.”

Gifting of appreciated stock

Given the nature of our business, in our opinion the most obvious and effective way to give to a charitable organization is through a gift of appreciated stock. This is a win-win situation for both the taxpayer and the charity. The taxpayer can deduct the market value of the stock on the date of the gift and the charity gets the donation. Furthermore, by donating the appreciated stock rather than selling the stock and donating the cash proceeds, the taxpayer also avoids any capital gains tax. Note that this only will work with appreciated securities within taxable accounts. Should you hold a stock that has depreciated in value, it is generally wise to sell the stock and donate the cash proceeds. Utilizing this method, the taxpayer can write off the capital loss up to current IRS limitations.

In addition to shares of appreciated stock, those so motivated can use other appreciated assets as well, such as bonds, mutual funds and real estate.

One final way to get into the charitable-giving mood this holiday season is through gifts of life insurance policies. To accomplish this transfer, the current owner must name the qualified charity as either the new owner or the irrevocable beneficiary. If the owner does one of these, then he/she is able to obtain a tax deduction on the present value of the insurance contract or his/her accumulated premium payments, whichever is higher.

As always, please be sure to first check with your tax advisor.

Please note that all data is for general information purposes only and not meant as specific recommendations. The opinions of the authors are not a recommendation to buy or sell the stock, bond market or any security contained therein. Securities contain risks, and fluctuations in principal will occur. Research any investment thoroughly prior to committing money or consult with your financial advisor. Note that Fagan Associates, Inc. or related persons buy or sell for itself securities that it also recommends to clients.  Consult with your financial advisor prior to making any changes to your portfolio. To contact Fagan Associates, call 279.1044.


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