With the new year coming on fast, now is the time for some last-minute moves to reduce your taxes for this year. After the markets close for the year, it will be too late. Other deadlines come in April. (Per usual, realize I am not a CPA or tax attorney and you should consult one or do your own research on the tax laws before you take my advice. This is just what I’ve learned as an investor and taxpayer.) Here’s what to do now:
Sell some of your losers to offset your winners. If you have some stocks you’ve made capital gains on this year, you can offset those gains by selling some of the stocks that have gone down. You can also offset some of your ordinary income with investment losses. It is a good day to search through your portfolio for that stock that just didn’t work out and sell out. Also, if you have more investment losses than gains this year (and that would be hard to do with the S&P 500 up almost 30%) you might think of trimming one of your big gainers back, using the loss you have to offset some of the gain and reduce the taxes.
Note that you need to be careful to avoid what is known as a wash sale. A wash sale is when you sell a stock at a loss and then buy the same stock back within 30 days. It is also a wash sale if you have bought within 30 days before you sell it at a loss. The tax man is wise to the game of selling to take a loss and then rebuying quickly so that you really haven’t taken the loss, and therefore the wash sale rules were created. You can also run into issues if you buy something essentially the same as the position you closed out within the 30 days. This mainly applies when you are dealing with options, however, and not if you sell Coke and buy Pepsi, for example.
Note also there are no wash sale rules when you made a profit. The tax man would love for you to sell shares you made a big gain on and then buy them again, realizing the gain and paying the taxes. Why would you do this, however?
Never, however, make a buying or selling decision based just on taxes. Don’t sell out on a stock that you still think has great potential but which has declined a little since you bought it just to realize the gain, thinking you’ll buy it back in 30 days. In practice, you’ll find you’ll never buy it back and you’ll miss out on some big gains that will make the tax savings look like chicken feed. Also, don’t hold onto a stock that has stagnated just because you don’t want to pay the capital gains taxes. You’ll find a little decline in the price of a stock, or the loss of the opportunity to make money elsewhere, will easily cost you more than the taxes you would pay. Make decisions based on the fundamentals of the company. Let taxes influence the timing a little, but not the decisions.
Fund your IRA, educational IRAs, HSAs, and other accounts. Some of these, like IRAs, let you wait until April to make a contribution for 2013, while others don’t. In either case, who knows if you’ll remember by April or have the money then? If you have the money to fund these accounts through some year-end bonus or Christmas gift money, do so. Otherwise, fund those that have a December 31, 2013 deadline and make plans in your budget to fund the others before April 15th. You’ll be saving taxes now (in the case of traditional IRAs and so on) or be getting tax-free growth later (in the case of Roth IRAs and the like).
Set-up an appointment with a CPA or tax attorney. You can do a lot better on taxes if you plan ahead rather than try to clean up the mess later. Schedule a yearly meeting with a CPA or tax attorney and develop a plan to save on taxes. They will know the latest tax laws and ways you can cut your taxes. Unfortunately, our tax law is such that if you do the same thing two different ways, you’ll owe different taxes. The tax payer is left to figure out the best way to save on taxes. (Let’s eliminate this. Learn about the Fair Tax and call your US Congressman to lobby for it. Then, you can stop worrying about the IRS and all of the planning and record keeping entirely.)
Start planning your budget for FY2014. Take some time now or after the new year to plan out a budget for FY14. This won’t reduce your taxes necessarily (although tax planning could be part of it), but if you take control of your spending now you’ll have more money later. Estimate all of your income from jobs and other sources. Estimate your recurring expenses like mortgages, insurance, utilities, and food. Then decide how much you’ll save and invest and how much you’ll spend on luxuries and optional expenses. Try to fund retirement accounts fully (10-15% of your paycheck) and put money away for the kid’s college. If you don’t have a good emergency fund (3-6 month’s worth of expenses in cash), plan to build one, and fast. Then, plan reasonable amounts for gifts, vacations, meals out, and so on. If you find you have nothing for saving and investing, look where you could cut back a bit on something. Also, don’t forget to start saving for car and home repairs, or a replacement for the cars you are driving.
Once you have the budget for the year planned, which gives you the yearly goals for saving and investing and guidelines for luxury spending, start one specifically for January. In this month-specific budget, list income you will receive in January and expenses specifically for the month. If you have money left over this month, direct it to one of your saving/investing goals or put it into a specific savings account for an upcoming vacation or other expenses. If you contribute to one of your saving/investing goals, note it on your yearly plan and keep track through the year until the goal is met. (Note, in many cases, directing a specific amount each month, especially through automated withdrawals, is the best way to keep the discipline.) Do this each month and hold yourself to your plans for the month
Close out 2013 with a plan and you’ll be glad you did. Then, execute it in 2014 and have a happy new year.
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Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.