Minimizing Capital Gains Taxes
March 21, 2011
by Alan Haft
March is one of my favorite months of the year. Winter’s just about over, NCAA March Madness is around the corner, the NBA the playoffs are coming up, flowers are getting ready to bloom and topping the list is the fact that most of us get to spend time preparing to pay taxes.
How great is that?
Although I’m certain the government is going to put our tax payments to good use, I prefer to minimize the amount I pay and that’s why I pay attention to how I might lower them, especially on things such as capital gains.
Capital gains are certainly nothing new to CPAs but to many clients, capital-gains distributions remain one of the great mysteries of accounting. For this reason I thought a quick column on what they are and how to potentially reduce them could be of some help.
Capital Gains 101
As an investor, sometimes your clients sell shares of an investment, such as a stock or a mutual fund. When your clients make money on that sale, they realize a capital gain.
But that’s not the only type of capital gain that exists. Each year, a mutual fund must distribute to its shareholders a portion of any net capital gains it earned when it sold securities in its portfolio. (Net capital gains are what remain after capital losses are subtracted from capital gains .) As a shareholder, you must pay taxes on those gains. So, even if your clients didn’t actually sell any of their fund shares, they could end up paying capital-gains taxes.
As unfair as it sounds, this is what I often refer to as the Mutual Fund Twilight Zone Paradox. sometimes funds pay out capital gains distributions in years that they’ve actually lost money. In 2002, for example, the performance of many funds was down. But at the same time, to meet redemption requests, many fund managers were forced to sell profitable growth stocks they’d held during the run-up of the 1990s. As a result, many shareholders were stuck with funds that lost money, yet still owed taxes on capital-gains distributions from the funds.
In addition and unbeknownst to some, “tax free” municipal-bond funds may realize capital-gains tax from selling bonds at a profit, even though the funds are managed for tax-exempt income .
Minimizing Capital Gains — and Taxes
If your clients are unhappy with the amount of taxes they pay, you may want to encourage them to start planning now to ensure that next year they maximize the money that goes into their own pockets and minimize the money that goes into Uncle Sam’s.
Here are some tips that could help:
- Minimize your capital gains: This one is simple, my favorite and the one I’d have to say is most often missed. Those planning on selling shares of stock or a mutual fund can potentially reduce their taxable gains by selling shares they bought at the lowest or highest price (which to sell depends on a number of factors too lengthy to explain here).
all gains long-term gains:Short-term capital gains are gains from sales of property held one year or less; long-term capital gains are gains from sales of property held for more than one year. In tax year 2010, short-term capital gains are taxed at an investor’s ordinary income rate, which may be as high as 35 percent, depending on your client’s income level. Long-term capital gains, on the other hand, are taxed at a maximum rate of 15 percent: In tax-year 2010, investors in the two lowest tax brackets (10% or 15%) pay zero percent in long-term capital gains tax while everyone else pays 15 percent. So unless your client is in the lowest income tax bracket, they’ll pay lower taxes on capital gains if they hold securities for more than one year.
As you can likely tell by now, minimizing capital-gains taxes is not the easiest endeavor but hopefully some of the thoughts above can be of help as you advise your clients this busy season.