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Tax Strategies That Stick

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It’s that time of year again when many of us are faced with preparing and filing our tax returns. As you issue that sigh of relief that comes from knowing that the annual “IRS ordeal” is over for another year, keep in mind that pursuing a tax-efficient financial strategy all year round can help ensure that you’re keeping more of your hard-earned money and paying less to the US Treasury. Some tips for being consistently “tax-conscious” throughout the year are presented below. Not only can you reap the benefit of paying less in taxes, you can also reduce your level of “tax stress” during tax season.

Consider Tax-Loss Harvesting All Year Long

Tax-loss harvesting involves using the losses from the sale of one investment to offset gains made from the sale of another investment, lowering the federal tax owed that year. By strategically selling losing positions, you can use these losses to offset gains realized elsewhere in your portfolio, thereby reducing your overall tax liability. If an investor has no capital gains to offset in the year the capital loss was “harvested,” the loss can be carried over to offset future gains or future income. There is no expiration date.1 Money saved on taxes in the current year can then be reinvested to drive the growth of your portfolio. Implementing tax-loss harvesting periodically throughout the year can help individuals mitigate taxes on investment gains and potentially improve after-tax returns. With the help of your financial advisor, keep an eye on assets that are priced below where you bought them. You don’t have to wait until the end of the year to strategically harvest losses.

Maximize Retirement Contributions to Minimize Taxable Income

Are you maxing out your traditional IRAs, Roth IRAs, 401(k), or 403(b) accounts? Depending on your circumstances and future income projections, these accounts can help lower your current taxes. Not only will you defer taxes until later years when you may be in a lower tax bracket these contributions enable you to simultaneously save for retirement. Additionally, contributions to retirement accounts grow tax-deferred until withdrawal, providing further tax benefits in the long term. And if you qualify, don’t forget about health savings accounts (HSAs), which allow you to reduce taxable income by making contributions that can later be withdrawn tax-free for qualified healthcare expenses. As part of your year-round tax planning, keep in mind that systematic deposits made throughout the year can ease your cash flow burden at tax time.

Consider Tax-Efficient Investments to Reduce Taxes

By strategically selecting investments with tax implications in mind, you can reduce your overall tax burden and potentially increase your after-tax returns. Investing in assets like municipal bonds or index funds with low turnover ratios can minimize taxable events such as capital gains and dividends. Municipal bonds, for example, are debt securities issued by local governments and are often exempt from federal taxes and, in some cases, state and local taxes as well. This exemption can make them particularly attractive for investors in higher tax brackets seeking to reduce their tax burden. Additionally, investing in index funds or exchange-traded funds (ETFs) with low turnover ratios can be tax-efficient. These funds typically generate fewer taxable events such as capital gains distributions compared to actively managed funds, resulting in potentially lower tax liabilities for investors. Regularly reviewing and adjusting investment portfolios for tax efficiency can be a proactive approach to tax management throughout the year. 

Plan Charitable Giving Strategically

The Tax Cuts and Jobs Act of 2017 doubled the personal exemption, making it less practical for most filers to claim charitable deductions on an annual basis. However, you may benefit by strategically bundling what would normally be two or more years of deductions into one and claiming a larger deduction in the year the donation is made. By strategically planning charitable contributions, taxpayers can maximize the tax benefits of their donations while making a positive impact on their communities. Donations aren’t limited to cash. Donating appreciated assets such as stocks or mutual funds directly to charities can offer significant tax advantages, including avoiding capital gains taxes on the appreciation and potentially qualifying for a charitable deduction. You may also want to consider contributing to a donor-advised fund (DAF). A donor-advised fund, or DAF, is a giving account established at a public charity. The 501(c)(3) public charity serves as a “sponsoring organization,” which manages and administers individual DAF accounts. DAF accounts allow donors to make a charitable contribution, receive an immediate tax deduction and then recommend grants from the fund over time.  Donors can contribute to the fund as frequently as they like, and then recommend grants to their favorite charitable organizations whenever it makes sense for them.2

Project Your Tax Situation

With the help of your financial advisor and tax specialist, prepare a tax projection for the next tax year. This “preview of coming taxes” can then serve as a planning basis for all the strategies mentioned above. It can also give you an overview of where you are now and time to get to where you want to be by the next tax filing deadline. At Treehouse Wealth, we can provide you with information and insights to help reduce “tax-stress” that often afflicts so many of us at tax time.

1 Carol M. Kopp, March 14, 2024, How Tax-Loss Harvesting Works for Average Investors, Investopedia
2 What is a Donor Advised Fund?, National Philanthropic Trust

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