We are big fans of the saying, “Give to Caesar his due, but not a dollar more!”, which is why at our firm we focus on helping clients create tax efficient retirement plans and portfolios. With tax filing season upon us, we thought we’d share a few common issues we see when reviewing previous tax returns of new clients.
1) Selling too soon- Depending on when you sell an investment, you can pay anywhere from a 0% federal tax on your gains to a whopping 40.8%! Losing 40% of your gains to federal taxes when you could potentially lose nothing dramatically changes how much of your profit actually ends up in your pocket. Waiting to sell an investment after you’ve owned it for at least a year and/or when your income may be lower can significantly decrease your tax burden.
2) Poor recordkeeping- Prior to 2012, it was up to the taxpayer to keep a record of the purchase price of their investments. Thankfully, since then brokerage firms have been required by law to keep track of this information and relay it to any firm an account may subsequently be transferred to. Despite this change, we have seen situations where this information isn’t transcribed properly or at all and investors pay tax on the entire sale price of an investment, rather than on just the gains. This happens even more frequently with investments bought prior to 2012, as firms won’t always provide the original cost on tax forms in this scenario. If you’re filing your own return, pay careful attention to tax documents when you receive them and don’t blindly input numbers from these forms into tax software. If you’re utilizing a professional to help you file your taxes and they don’t catch this problem, you may want to consider a different preparer.
3) Not using losses optimally- With financial markets experiencing a bumpy ride in 2022, you may have losses in some of your investments. While having losses isn’t fun, don’t add insult to injury by failing to use them in the most tax advantageous way possible. Losses from prior years can be carried forward to future tax years and can be used strategically. For instance, it makes far more sense to offset your gains with losses if you’re faced with a 40.8% tax versus a 0% tax, like in pitfall #1. You can also use up to $3,000 worth of losses per year to offset the tax on other income that may be taxed at a higher rate. When an investment is sold should not be based solely on performance. Having a strong return is nice, but keeping more after taxes is nicer. If you fail to account for tax implications, a large investment gain could result in less money making it back to your bank account versus a smaller gain with smart planning.
4) Buying too soon- Washing dirty hands before eating is a good idea, but rebuying an investment you recently lost money on usually isn’t. Why? Well, if you sell an investment for a loss, but repurchase the same or a substantially identical one within 30 days you can’t claim the loss on your taxes. If you’re looking to maximize your after tax investment return, which investments you buy and when can sometimes be just as important as which investments you sell and when.
5) Missing tax breaks- According to the IRS, over 1/3 of all errors on tax returns involve either the child tax credit (16%), earned income tax credit (10%), or taking deductions (8%). These 3 are the most commonly caught by the IRS as they’re usually something computer systems can catch automatically, but you shouldn’t bank on the IRS finding missed tax credits or deductions for you. With the myriad of newly available tax breaks as part of the recently passed inflation reduction act for certain car purchases and home improvement projects (many of which have complicated requirements), you may want to seek out a second opinion as to whether you’re receiving every tax break you’re entitled to.
6) Using the default tax plan- Taxes are complicated. There are over 6,800 pages of tax code and 70,000 pages of interpretations and guidelines related to that code. When confronted with something this overwhelming, it is easy to throw up your hands and say, ‘whatever I owe, I owe’. The issue with taking this route is that you’re accepting the ‘default tax plan.’ Given that the default plan was created by the government, who do you think it benefits most?
Being able to select great investments is only one small part of creating the highest investment return that you can keep and spend in retirement. It doesn’t necessarily matter how much you make with your investments, it matters how much you keep after taxes since what you keep is what you can spend. Unsuccessful investors react to what has already happened, while successful ones continuously act on a plan, so get a tax plan you’re continually acting on. Don’t get stuck reacting to the default tax plan as that can be quite costly.
If you’re in the Topeka or Lawrence area and looking for help from a financial planner to assist in reducing your taxes on your investments and retirement income, fill out the form below or give our office a call at 785-330-9292.
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