We all know the saying: in this world, nothing can be said to be certain, except death and taxes. Taxes are an inevitable and important element of our society, but it can be frustrating to watch a substantial chunk of your hard-earned wealth taken away in taxes before you have the chance to do the things you want with it.
That’s where tax efficiency comes in. Without much extra effort on your part, you can take that same wealth that you were accruing anyway and pay a lot less in taxes on it. Here are a few ways to get started.
1. Hold Stock Longer Than a Year
This is a simple tip: the taxes you pay on short-term capital gains are significantly higher than the taxes on long-term capital gains, and the cutoff between short- and long-term gains is one year. We’re not in the business of day trading at First Western Trust Bank, so we recommend that you hold the assets you acquire for at least a year.
Most brokerage apps can help you keep track of the date you acquired an asset and the price you paid for it, so when you do need to sell, you can make sure to sell the right stock.
2. Tax Loss Harvesting
We’d love to think that our investments only go up in value, but that’s just not the world we live in. If you’ve been diversifying well, you probably own a handful of different brokerage accounts, index funds, individual stocks, mutual funds, and other investments. Barring enormous economic upheavals, they generally don’t rise and fall at the same time. Markets do correct.
Lucky for you, you can sell those depreciated assets. The loss you take on those assets counts as a capital loss, which can be balanced against capital gains, dollar for dollar, reducing the amount you have to pay in capital gains tax.
When you sell that asset, though, use the cash to turn around and buy another asset at the same price. You can’t do that for at least 30 days, thanks to “wash-sale” rules, but 30 days isn’t very long in market terms. You’ve created a capital loss that can offset your tax bill and you’ll still be able to benefit when the market recovers.
3. A Diversified Portfolio
Another way to defray capital gains tax is by investing in a diverse set of assets. There are certain well-known inverse relationships in investing — for example, when the price of gold goes up, the value of the dollar tends to drop. By investing in both sides of those coins, you can leverage one asset as insurance against the value of the other. If one asset rises in value and the other falls, you can sell some of both and let the capital losses offset the gains.
4. Bunch Charitable Donations
The standard deduction for single people in 2020 is $18,650 and the standard deduction for married couples filing jointly is $24,800. If you’re married, don’t have a mortgage, and you’re giving $10,000 a year to a charity you care about, you might not hit that deduction, which means you’re leaving money on the table. Instead, consider giving $30,000 to that charity this year, then nothing for the next two years. You’ll get the tax benefit from your large donation, then you can take the standard deduction for the next two years. The downside is that you’ll probably get emails from charities who are confused by a huge donation followed by several years of inactivity, but you can offset that problem with our next tip.
5. Set Up a Donor-Advised Fund
A donor-advised fund (DAF) is a special kind of financial vehicle that you can set up. You can put any amount of money into it at any time — let’s say the same $30,000 that we just mentioned. You’ll receive the full tax break on that amount in the year you put it in the account. At that point, the money in the fund can be invested however you want, or you can leave it there to grow, tax-free.
If you anticipate a major tax event, like a sudden boost in income from selling your business, you can put all the money into the DAF and reduce your tax liability, then let it grow and donate it over the next ten years.
6. Donate Appreciated Stock
Donating cash to a charity is great, but donating stock is even better. The charity can sell it if they want, or they can keep it and let it grow. Better yet, you get a deduction for the value of the stock on the day you donate it, and you don’t pay anything for the capital gains. If you buy $10,000 in stock and donate it at $30,000, you’re getting a deduction for the full $30,000 without paying taxes on the $20,000 increase in value.
It’s good news for the charity, too — they get $30,000 in stock and don’t have to pay any tax on it because they’re non-profit organizations.
Talk to the Experts
The U.S. Tax Code is so long that no one actually even knows how long it is, so tax planning can be a fiendishly complicated process if you don’t know how to navigate it. Luckily, at First Western Trust Bank, we do. We have decades of experience with people just like you, helping you find the best way to manage your wealth so that you don’t lose it all to taxes.
We don’t pigeonhole — for every client, we’ll examine your assets, liabilities, goals, and priorities to find the financial strategy and plan that’s right for you. If you’re ready to start taking your financial future seriously, get in touch.