Pay Less Tax on Your Investments

It’s great to accumulate wealth by investing and saving you money, but did you know that taxes can take a large bite from your investments? Every investor, including those with 401(k)’s, IRA’s, and traditional brokerage accounts need to be aware of the impact of taxes. Here are a few tips and items to watch out for:

401(k)’s: A 401(k) can be a great way to save money for retirement as it is automatically deducted from your paycheck every time you get paid. If you are in the 25% tax bracket, every $100 you contribute saves $250 in taxes, plus savings for state taxes as well. You want to contribute as much as possible to reduce your taxes and save for retirement, especially if your employer has a matching contribution.

There is one common mistake that I do see often with 401(k) accounts and that is withdrawing money before retiring. It could be because you really need the money or you switched jobs and cashed out your account. You must resist the temptation to do this! Generally, there is a 10% early withdrawal penalty plus you will owe income taxes on the money withdrawn. This can easily add up to a third or even half of the money lost to taxes that you have withdrawn!

IRA’s: An IRA (individual retirement account) has similar tax characteristics of a 401(k). A strategy to maximize the tax-efficiency of your IRA may be to convert some or all to a Roth IRA. A Roth IRA has more favorable tax aspects as there are no taxes when you make a qualified withdrawal. Before making this decision, a thorough analysis should be done to make certain this strategy is beneficial for your situation.

Traditional Brokerage Account: A regular taxable investment account needs to be monitored closely to make sure you are not unnecessarily paying taxes. There are three straightforward ways to do this:
- Invest in tax-efficient mutual funds, ETF’s, and reduce the number of times you trade in your account. Every time stocks or bonds are sold, it may result in additional taxes
- Hold your investments for longer than one year to pay lower capital gains tax rates. This strategy compliments the first point.
- Compare the returns of tax-free municipal bonds to regular bonds to see which produces the higher overall rate of return.

Bad Tax Planning

Tax planning can prevent you from overpaying taxes, but it has to be done before the year is over. Good tax planning takes a proactive approach, and bad tax planning includes either not planning, breaking the law, or taking it upon yourself without using a competent tax professional.

Without planning you may not be able to take advantage of the ever-changing tax laws. When we work with business clients either monthly or quarterly we are able to understand their business finances much better. By doing so we can suggest proactive ways to reduce taxes, run their businesses better, and help with cash flow and profitability. For example, if your business is doing well, it makes sense to review the current structure to make sure that it is tax-efficient. Our services are designed to save much more in taxes and produce more value than our fees.

A bad strategy is to pay for personal expenses through the business and take a deduction for it. Personal expenses should be kept separate and paid for personally. An IRS auditor can easily spot this, assess more taxes, and even assess penalties of 20% or more. And of course, underreporting your income is not wise either and may result in criminal prosecution.

I know what I know and know what I don’t know. I use other qualified professionals when it comes to legal matters, insurance, and healthcare. If you take it upon yourself to do your own tax planning, you usually end up unknowingly paying more in taxes than the cost of using a professional. The key is to make certain that you choose the right professional and ask a lot of questions.

Did You Have Damage From Hurricane Irene?

Hurricane Irene caused a lot of property damage due to intense winds and rainfall. Many areas along the East Coast lost power for days and had flooding that has not been seen before. Most importantly, I hope that you were all safe.

Due to damage incurred from the hurricane, you may be able to deduct some of the damage to your property and belongings. These are called casualty losses and the definition is as follows:

A casualty is the damage, destruction, or loss of property resulting from an identifiable event (such as a hurricane, storm, or car accident) that is sudden, unexpected, or unusual.

The rules can be complex when figuring out your deduction. Generally, you can deduct your loss by using this formula: the loss minus insurance proceeds, then subtract $100. Finally, subtract 10% of your adjusted gross income from that figure to arrive at your deductible loss. Also, you need to be an itemizer in order to deduct casualty losses.

Let’s simplify with an example: Your car originally purchased for $30,000 is now worth $15,000. It is completely destroyed by Hurricane Irene, and your insurance reimbursed you $10,000. Your loss is then $15,000 - $10,000 = $5,000. Then subtract $100 to arrive at $4,900. Finally, subtract 10% of your adjusted gross income (let’s assume it is $40,000, then multiply by 10%) of $4,000. Your deductible loss is $900.

The rules are different for business owners. You may even be able to file an amended return from the prior year to receive a refund. As you can see the rules can be complex, so do not hesitate to contact our office with any questions.