Paying Taxes on Your Investment Income

Written by Lester Detterbeck.



Press Release: On November 6, 2018 (Midterm Election Day), SC Public Radio Host interviewed Les Detterbeck. The message: Income Tax Planning for your Investments is very important.

Click here to listen to the audio and/or please read the transcript below.

Mike Switzer: There are two basic truths. We all love when the stock market makes us money. We all hate paying income taxes on those profits. But you still have almost two months to get your investment tax planning in order, so today we have a guest that may be able to help. Les Detterbeck is a Chartered Financial Analyst and Les is also a Certified Financial Planner and CPA. Les joins us from his office in Charleston, SC. Welcome, Les. Thank you for joining us today.

Les Detterbeck: Thank you, Mike for inviting me. Good to speak with you today.

Mike: So, let’s go ahead and dive right into these tips. What’s number one?

Les: Tip #1 is that each year you should go through your portfolio and identify those unrealized losses, that is where the current value is less than your cost. You should go ahead and harvest these losses by selling the securities so that these losses can come into your tax return for that given year. Of course, the losses would offset your capital gains for the year with the net objective that you will have no taxable capital gains for the year.

Mike: You’ll have a limit on the amount of loss you can take if you don’t have enough gains, correct?

Les: Exactly right, Mike. You have a $3,000 annual limit with the excess being carried forward indefinitely. Again, what can happen, because we have had a big pullback in October, you can harvest losses this year because you might need them next year. That wouldn’t be a bad strategy.

Mike: Does your tax bracket matter?

Les: The tax bracket does matter. The general tax rate for capital gains is 15%. However, for the lowest tax brackets, capital gains are taxed at 0% and for the highest brackets at 20%. And, of course, I am only referring to the federal income tax as there is SC tax as well.

Mike: Okay. What’s next?

Les: The next tip, Mike, is to always look at both asset allocation and asset location. You have three types of investment accounts: taxable, tax deferred or tax exempt. For taxable accounts, you must pay taxes in the year income is received. Retirement accounts, IRAs and annuities are examples of tax deferred accounts, in which you pay tax on the income when you take it out. Tax-exempt accounts, like Roth IRAs and Roth 401ks, are not taxed even at withdrawal.

Tax efficient investments should be in taxable accounts, tax inefficient investments should be in tax deferred or tax-exempt accounts. Stocks or equities are tax efficient- if you hold them for more than a year, you pay capital gains taxes not ordinary income.   Bonds/fixed income are tax inefficient. Interest earned on bonds in taxable accounts is income in the year received and is taxed at ordinary income tax rates. Income in a tax deferred account, such as an IRA or retirement account is taxed as ordinary income but only at withdrawal. Hence, the most efficient overall asset location is to put stocks/equities in taxable accounts and fixed income and alternatives in tax deferred accounts.

Mike: And, I heard you mention Roth IRAs. Is there anything there specifically that we should know about for our planning.

Les: Yes, Roth assets are tax-exempt, which makes them the most valuable investment you can own. Furthermore, Roth accounts, unlike traditional IRA accounts, do not require minimum distributions when you and/or your spouse reach 70 ½. Upon your passing, the beneficiaries of your Roth assets can “stretch them” by allowing them to continue to grow them tax-free over their lifetimes. Therefore, you want these assets to be able to grow as significantly as possible consistent with your risk profile and asset allocation.

Mike: And, we have time for one more tip.

Les: My final income tax planning tip today would be to do an Income Tax Projection. Do it yourself or work with your CPA. You need to look at it particularly for 2018 as the Tax Reform made some big changes this year. Review your income, deductions, tax bracket and estimated taxes. Two principal reasons, Mike. One, a projection will help you minimize surprises and penalties. And, two,

hopefully, you will come up with some tax savings ideas, some of which may need to be put into effect before December 31.

Mike: Les, thank you so much for the information and your time today.

Les: Thank you, Mike. Pleasure to be with you.

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