Managing your investment portfolio to minimize tax expense

2016 has come and gone, but as the Dow and financial markets continue to reach new highs, now is as good a time as any to review your investment portfolio and activity for its potential tax implications. Paying tax on investment earnings typically means that your investments are doing well, but there are some things you can do to minimize your tax exposure. Before we begin, let's talk about all the ways your investments are taxed (important caveat, tax reform in 2017 is being talked about but this writer will only believe it when it actually happens). Dividends: Qualified dividends are taxed at 0%, 15% or 20% depending on your tax bracket. Most dividends from US Corporations are qualified assuming you own the stock for more than 60 days. Nonqualified dividends are taxed at your usual income tax rate. Interest: This is taxed at your usual income tax rate. Capital gains and losses: If you buy stock and hold it for longer than a year, you will be taxed at either 0%, 15%, or 20% when you sell it depending on your tax bracket. For most of you, your rate is 15%. For stocks held less than a year, your gains will be taxed at your ordinary income tax rate. Investment tax (Medicare Surtax): If your modified adjusted gross income is over $200,000 for single filers or $250,000 for joint filers, you get the honor of funding Medicare expansion, courtesy of the Affordable Care Act. For this honor you will be taxed 3.8% on investment income such as taxable interest, nonqualified dividends, and realized capital gains. Ok, so that is how you can get taxed, but what can you do to minimize your tax? Hold stocks longer Pretty simple one here, owning a stock longer than a year saves you money on taxes (ordinary vs. capital gains rate). Also selling and buying stock frequently can increase your investment fees if you pay per transaction. For you day traders out there, you already know the risks. Get the right mutual fund or ETF Many of you own mutual funds instead of personally owning stocks; in that case there are many tax-managed versions of mutual funds that limit the number of sales and other taxable events that you could get docked for. ETFs are naturally tax-efficient and are a great choice for the tax-conscious investor. Invest in Municipal bonds or other tax-exempt assets Another obvious one, but municipal bonds provide tax-free income to the taxpayer. What you gain in tax advantage you probably lose in return potential, but for someone seeking a diversified portfolio this is a good option. Use your 401k or other tax advantage accounts wisely 401ks, IRAs, or 529 plans all offer tax advantages, either tax deferral or tax-free growth. Taking advantage of all the plans available to you can help you minimize your potential tax. Whether you do it by yourself or with an investment adviser, lining up all of your investments and accounts in one place is a great way to see what could be changed to minimize your tax. Selling at a loss The professionals call this tax-loss harvesting. This involves reviewing your investments every quarter or so for loss positions that could potentially offset capital gains. Professionals do not recommend selling stock to simply reduce capital gains, but this is not a bad process to go through if you want to rebalance your portfolio. Important note, net tax losses are limited to $3,000 per year, which can be used to offset your ordinary income. Another important note, if you sell a stock to "harvest" the tax loss then immediately repurchase the stock because you still want the investment, the IRS will catch you. There has to be at least 30 days between sale and purchase, otherwise your loss will be disallowed. These are some pretty simple steps to help you manage your tax liability, and remember that if you are paying taxes you must be doing something right with your investment choices. ----- Greg H. Carver, CPA, is a manager with Mengel, Metzger, Barr & Co. LLP and may be reached at gcarver@mmb-co.com. Published: Mon, Mar 20, 2017