The end of the year is a great time to assess your current investments from both a tax, and a financial perspective. Depending on your situation, you might rely on four key strategies to improve your tax picture for 2016:
1. Capital loss harvesting: Capital losses can offset taxable capital gains, and if your losses for the year exceed your gains, you can use the excess to offset up to $3,000 of highly taxed ordinary income, such as the salary from your job. If you still have an excess loss, you can carry it over to use in future tax years.
This presents some tax planning opportunities at the end of the year. For instance, if you've already realized a short-term capital gain that will be taxed at ordinary income rates, you could sell a holding at a loss to offset all or part of that gain.
2. Capital gain harvesting: On the flip side, you might use an existing loss on a securities sale to absorb the potential tax from a capital gain. For example, if you've taken a loss, you might harvest a short-term capital gain that otherwise would be taxed at ordinary income rates.
If you have a long-term capital gain (from selling an investment you've held longer than a year), you benefit from a maximum tax rate of 15%, even if you're in the regular 25%, 28%, 33% or 35% bracket. Those in the top 39.6% bracket pay a maximum 20% rate on long-term capital gains. And investors in the two lowest brackets of 10% and 15% pay 0% on long-term gains.
3. Wash sales: Under the wash sale rule, you aren't allowed to deduct a capital loss on the sale of securities if you acquire substantially identical securities within 30 days of the sale. For instance, if you sell mutual fund shares at a loss and buy back shares of the same fund two weeks later, you can't claim the loss.
In this case, all you have to do is wait at least 31 days before buying comparable securities. Alternatively, if it makes financial sense, you could buy the new shares right away and wait at least 31 days before selling the original shares.
4. NII tax: You could owe an additional 3.8% surtax that's applied to the smaller of your net investment income (NII) or the amount by which your modified adjusted gross income (MAGI) exceeds $200,000 for single filers and $250,000 for joint filers. The definition of NII includes most taxable income such as capital gains from securities sales.
To reduce your NII tax exposure, you might defer realizing capital gains until next year. And investments producing tax-free income, such as municipal bonds, are exempt from the NII calculation.