Though the ink’s barely dry on your return for 2014, getting an early start on tax planning for 2015 can save you both money and stress next April. Here are five techniques to keep in mind.
1. Tax-loss harvesting
If you already realized a large capital gains tax in 2015 or anticipate one later this year, this tactic might help. Loss harvesting involves selling an investment at a loss and simultaneously buying a similar, substitute investment.
Let’s assume that you purchased $10,000 worth of oil company ABC stock last year. Due to lower oil prices, your investment drops in value to $7,000. If you take no action and oil prices rebound, raising the stock price, you receive no tax benefit for the temporary $3,000 loss from your stock.
If you sell your ABC stock and buy a substitute simultaneously (say, in oil company XYZ), you can use the $3,000 to offset gains on your tax return and participate in the stock price recovery that accompanies eventually rising oil prices.
You can use this strategy with individual securities (stocks) or with diversified bundles of securities, such as mutual funds and exchange-traded funds. Either way, you can lower your capital gains liability and possibly achieve greater after-tax returns.
2. Optimized charitable giving
Increasing your donations in the year that you realize a large capital gain can also help reduce your tax liability.
If you don’t have a favorite charity and need time to research qualified organizations before making a contribution, consider creating a donor-advised fund (DAF) to take a tax deduction in the year that you make the contribution (in this case, 2015) and make grants to your favorite charities in the future.
Funds in a DAF can be invested to grow over time. You can also contribute to DAFs with appreciated securities that are now worth more than when you bought them, giving you two tax breaks: on the charitable contribution and on the unrealized capital gain in the investments.
You can even create a board of advisors for your DAF to get other members of your family involved in grant decisions.
3. Higher retirement plan contributions
For 2015, your maximum deferral to defined contribution plans (to which you kick in a set fraction of your pay) increased to $18,000, and the catch-up contribution for those 50 and older increased to $6,000 — a total of $24,000 in potential tax deferrals.
Consider increasing your contributions to match these limits, which can also reduce your taxable income. Contact your plan administrator for more information.
4. A Roth individual retirement account conversion
Such switches from an existing IRA or employer-sponsored plan were once only available to investors with modified adjusted gross income (MAGI) of less than $100,000. Congress eliminated that restriction in 2010, making Roth IRA conversions available to nearly all investors regardless of marital status or income level.
You can benefit from a Roth IRA conversion if you expect your taxable income to be significantly lower or your deductions to be significantly higher in 2015, or if you’re in a lower tax bracket now than your expected retirement tax bracket.
Best to be proactive: Ask your tax advisor to prepare a projection regarding your optimal amount to convert before December. If necessary, you also have until Oct. 15, 2016, to re-characterize your Roth IRA back into a traditional IRA.
5. Maximized company stock options
If you’re in an employer-sponsored stock option plan, start tax planning before the year in which the options mature to retain the most flexibility and savings.
If your options mature or start vesting in 2015, meet with your financial advisor to prepare tax projections. Planning ahead helps you get ready to take advantage of future tax savings as well as regulate your cash flow.
Integrating tax planning with your investment management optimizes your after-tax returns and enhances your whole financial plan, both in this year and in those to come.
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Lora Murphy, CPA, CFP, CDFA, is a consultant with Wipfli Hewins Investment Advisors LLC in Milwaukee.
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