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End of Year Tax Planning Strategies

Have you thought about tax planning strategies for the end of the year yet? Here are 5 potential options to review.

By John Weber

It may not be December, but it’s certainly not too early to begin brainstorming tax planning strategies. Listed below are five potential tax planning opportunities to consider.

John Weber is a Financial Planning Associate at Omega Wealth Management, a fee-only financial life planning firm based in Arlington, Virginia. Omega Wealth Management’s goal is to know clients on a personal level, integrating their values, vision, and wealth to provide holistic and comprehensive financial planning. John can be reached at john@omegawealthmanagement.com.

John Weber

Tax loss harvesting

Tax loss harvesting is the concept of selling securities at a loss to either lower your tax bill or offset capital gains realized throughout the year. If you are wondering why you would want to sell a security at a loss, you are asking the right question… I hope to help answer that question with the following example:

You own an individual stock holding with an unrealized capital gain of $50,000 and a bond market ETF with an unrealized loss of $50,000. If you wanted to realize the gains on the stock, but can’t get your mind around paying the taxes, you could also sell your bond market ETF at a loss, resulting in $0 in capital gains taxes owed. This may be particularly helpful for investors who are overly concentrated in individual stocks and are looking to diversify their portfolios.

Additionally, you are allowed to take a maximum of $3,000 in capital losses each tax year to offset your income. If you have more than $3,000 of capital losses, then the loss can carry forward to the next year and offset that year’s taxable income, up to the same $3,000 limit. Even if you do not have highly appreciated individual stock that you want to diversify, taking $3,000 in capital losses each year may be a tax planning strategy worth considering.

Roth IRA conversions

A Roth IRA conversion can be one of the most useful tools for investors looking to create tax diversification. At its core, a Roth conversion takes pre-tax funds (like that of a Traditional IRA, 401(k), or 403(b)) and modifies the funds to be post-tax money. When this conversion happens, you are required to report the entire amount as ordinary income for tax purposes. You may want to consider a Roth conversion for several reasons:

  • You have the expectation of being in a higher tax bracket in the future. 
  • You have a lower income year than normal. 
  • You have a long investment time horizon for the funds to grow tax-free. 
  • You wish to avoid mandatory required minimum distributions (RMDs) and have greater flexibility in your retirement money. 
  • You have significant assets for retirement and would like a vehicle to pass wealth to the next generation. 
  • You may not be eligible for regular Roth IRA contributions due to income limitations. 
  • You wish to have tax diversification and distribution flexibility in retirement.

Roth conversions can be done in a full or partial transfer. In fact, the strategy most often used is converting enough funds to “fill up” a certain tax bracket just before tipping into the next bracket.

To convert funds from your employer (such as a 401(k) or 403(b)), the IRS mandates that you must first have a qualifying event such as leaving your job, permanent disability, or plan termination. If you are converting money from your 401(k) to a Roth IRA, you can do so through either a direct rollover or an indirect rollover. A direct rollover is simply when your money or assets are electronically transferred to your Roth IRA account. An indirect rollover is when the funds are addressed to you, and you are responsible for later depositing the funds into the Roth IRA account. You have 60 days to deposit the money into your Roth IRA account or you will be subject to taxes and withholdings.

If you want to convert funds from a traditional IRA to a Roth IRA, you are able to do so at any time, so long as you keep in mind that the converted amount is now reportable as ordinary income for tax purposes.


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Qualified Charitable Distribution (QCD)

If you are charitably inclined, then you might consider utilizing a qualified charitable distribution (QCD). QCDs are when you distribute your required minimum distribution (RMD) from your IRA directly to a qualified charitable organization, lowering your taxable income. QCDs can be made with all or part of your RMD during any given year. The maximum current annual amount you can give via QCD is $100,000. QCDs may especially be useful when you do not need all the income from your RMD and wish to reduce your income for the year. It is important to note that not all charities are accepted for QCDs (for example, you are not able to send a QCD to a donor-advised fund) and you will want to check the specific charity before sending out the distribution to make sure it qualifies.

401(k) contributions

Contributing to your retirement account is another great way to reduce your income tax for the year. If you find yourself in a situation where you have stronger cash flow than needed, you might consider increasing your 401(k) contributions. The maximum employee contribution to a 401(k) is $20,500, or $27,000 if 50+ years old. Let’s look at the following example of how increasing your 401(k) contributions can lower your tax liability:

Assume your salary is $75,000, you contribute 6% to your 401(k), you are in the 22% marginal tax bracket, and you file as a single taxpayer.

$75,000 * 6% = $4,500 401(k) contribution

$4,500 * 22% = $990 in tax savings

Here’s what would happen to your tax savings if you were to increase your contribution to 10%:

$75,000 * 10% = $7,500 401(k) contribution

$7,500 * 22% = $1,650 in tax savings

You can also contribute up to $6,000 to a traditional IRA, or $7,000 if 50+ years old, and reduce your tax liability. However, there are several key details to consider if you are eligible for the tax deduction. You can find the specific details on the following IRS links below:

0% Capital Gains Rate

Yes, you read that right – no capital gains tax. Individuals with taxable income of $41,675 or less, or married filing jointly couples with taxable income of $83,350 or less may be eligible for the 0% capital gains tax rates. There are several reasons why you want to incur capital gains tax at a 0% tax rate, but I will discuss two: increasing your cost basis and providing tax efficiency.

Let’s say John and Jane are a married couple who have a combined household income of $60,000. They have been saving for a house down payment in a taxable account with a current value of $50,000 and a cost basis of $30,000. John and Jane could liquidate the taxable account, wait 31 days (to avoid any possible wash sale rule), and buy back the same exact funds.

So, what did John and Jane exactly do? They were able to realize $20,000 worth of gains, for zero capital gains tax liability. In addition, they were able to increase their cost basis. The result? Less tax liability, and more money in the pockets of John and Jane to pay for their house down payment. It’s important to note that some states require a state tax on capital gains tax, so it’s best to communicate with your tax adviser on your specific circumstance.

About the author: John Weber

John Weber is a Financial Planning Associate at Omega Wealth Management, a fee-only financial life planning firm based in Arlington, Virginia. Omega Wealth Management’s goal is to know clients on a personal level, integrating their values, vision, and wealth to provide holistic and comprehensive financial planning. John can be reached at john@omegawealthmanagement.com


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