Year-End Tax Planning Tips for Investors

It's December. Are You Ready to Adjust Your Investment Strategy?

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A number of tax-planning tactics are available to investors throughout the year. They can decide to sell off some investments, to make new investments, or they might commit to some combination of the two. These decisions are particularly relevant near the end of the year when investors begin to determine their net investment gains and losses so they can make adjustments that will have an impact on their tax returns.

Tax Planning Tips for the Year 2017

Be sure you understand what tax rate or rates will apply to the income you realize before you sell any investments. The following taxes are in effect in 2017: 

  • Ordinary income tax rates for 2017 have a top rate of 39.6 percent for the highest earners.
  • Long-term capital gains have a top tax rate of 20 percent. There are three long-term capital gains tax rates: 0 percent, 15 percent, and 20 percent. The 20-percent top rate applies to those who are in the 39.6 percent tax bracket.
  • Qualified dividends are taxed at the long-term capital gains tax rates. 
  • Investment income will be subject to the net investment income tax at a rate of 3.8 percent as of 2017. This surtax on investment income affects people who have adjusted gross incomes over $200,000 if they're unmarried or over $250,000 for married couples.

    Combining the capital gains income tax and the net investment income tax or NIIT, investors could face a marginal tax rate of 23.8 percent on long-term gains and qualified dividends. That's 20 percent for the income tax plus 3.8 percent for the NIIT. By contrast, short-term gains, non-qualified dividends, and interest could be taxed as high as 43.4 percent. That's the top income tax rate of 39.6 percent plus 3.8 percent for the NIIT.

    Check Your Cost Basis Reporting Settings 

    Brokerage firms began reporting the cost basis of investment products to the IRS, as well as to account holders, on Form 1099-B in 2011. Cost basis reporting expanded to mutual fund shares and stocks purchased through a dividend reinvestment program in 2012. During 2013, newly acquired bonds, notes, commodities and derivatives were covered under the cost basis reporting requirements.

    Investors should review their cost basis allocation preferences on their broker's website. You might want to use a different method than the broker's default methods. Compare your broker's data to your own records to make sure you have all the basis data you need to prepare your tax return.

    Consider Rebalancing Your Portfolio by Type of Tax

    Investments that produce ordinary income may fare better inside tax-deferred plans, and investments that produce long-term gains may produce more optimal tax results in taxable accounts. This is due to the lower tax rates that apply to long-term gains and is part of a tax strategy called asset placement.

    Selling Off Losing Investments

    This tactic accelerates losses into the current year. Capital losses can offset total capital gains. If you have a net capital loss for the year, up to $3,000 of that loss can be applied to offset your other income as of 2017. Any capital loss in excess of this annual limit can be carried over to the following year.

    If you repurchase the same investment within 30 days before or after selling an investment at a loss, however, your loss will automatically be deferred under the wash sale rule.

    Sell Off Winning Investments

    This tactic accelerates income into the current year and is ideal when an investor expects her tax rate in the current year to be lower than her tax rate in a subsequent year. Investors can also sell off profitable positions to absorb capital losses carried over from previous years. The downside of this tactic is that accelerating income also accelerates tax. Investors in the 10-percent and 15-percent tax brackets may want to consider selling profitable long-term investments to lock in the zero percent tax rate on capital gains.

    Investors who are in the 39.6-percent tax bracket may want to consider the impact of the 20-percent long-term gains tax rate and the 3.8-percent surtax before deciding to sell.

    Pairing Losses With Gains

    This tactic allows investors to offset gains from some investments with losses from others. It's known as loss harvesting and the goal is to try to minimize the total tax impact of selling investments at a profit by simultaneously selling off investments with losses. This is a hybrid tactic that accelerates income and accelerates losses to create the smallest possible tax impact in the current year. This tactic not only reduces the net gains subject to income tax, but it also reduces net gains subject to the 3.8-percent net investment income tax.

    Deferring Losses Until Next Year

    Taxpayers generally don't find themselves in a position to defer losses on investments because the tax code already has a provision for carrying over excess capital losses into a future year. The timing of selling off unprofitable investments can therefore be driven by your investment strategy rather than tax considerations.

    Deferring Gains Until Next Year

    Holding off on selling a profitable investment can potentially accomplish two things: It defers the income to another year, and you might be able to defer it long enough to have the gain taxed at the preferred long-term capital gains rate rather than as a short-term gain at ordinary tax rates. Long-term gains are those realized from investments you've held for more than one year. Deferring gains can generate a smaller tax bill for taxpayers who expect a significant decrease in their incomes next year because taxpayers in the 10-percent and 15-percent tax brackets have a 0-percent rate on long-term gains.

    Tax Planning With Capital Loss Carryovers

    Investors can use their capital loss carryovers to offset capital gains. Capital loss carryovers will become even more valuable for higher income persons who are subject to the net investment income tax. Investors may want to weigh the benefits of leaving some carryovers for later years compared to a strategy where losses are absorbed as quickly as possible.