Tax Time: A Perfect Opportunity to Review Your Investments

By: Ronald S. Zweig, CPA, Partner – Warady & Davis LLP and Registered Investment Advisor with RS Zweig Financial Advisors LLC

Being smart about your taxes isn’t just about making good decisions when you file. While you have your tax information in hand, it’s an ideal time to take a look at your investments and the types of accounts you have to make sure you’re getting the most tax benefits.

As an investor, your first priorities should be 1) to develop an asset allocation strategy that aligns with your investment objectives and risk profile, and 2) to select quality securities that support that strategy. Only after that’s done should you turn your attention to taxes and identify opportunities to improve the tax-efficiency of your portfolio.

Here are several planning strategies to consider:

  • Make the most of tax-advantaged accounts. Evaluate the tax-efficiency of each investment, based on factors such as dividend yields, fund turnover, and expected growth. To the extent possible, tax-efficient investments should be held in taxable accounts. Tax-inefficient investments should be held in tax-advantaged accounts, such as traditional or Roth IRAs, qualified retirement accounts, or education savings accounts. Tax-advantaged accounts may also offer opportunities to rebalance your portfolio tax-efficiently by containing asset turnover, to the extent possible, within those accounts.
  • Consider tax-efficient options. Examine investment alternatives that offer similar benefits in a more tax-efficient structure. For example, exchange traded funds (ETFs) typically generate fewer taxable gains than comparable mutual funds, and index funds tend to be more tax-efficient than actively managed funds.
  • Analyze tax-exempt investments. Consider tax-exempt investments, such as municipal bonds. But be sure to calculate the tax-equivalent yield to determine whether the tax savings compensate for reduced returns.
  • Harvest losses. Throughout the year, consider selling poor-performing investments to generate losses that can be used to offset capital gains (plus up to $3,000 of ordinary income). You can even buy the investments back, so long as you wait at least 31 days to avoid the wash sale rule.
  • Watch out for short-term gains. Gains on investments held less than a year are generally taxed as ordinary income and may also be subject to the 3.8% net investment income (NII) tax. There are several potential strategies for minimizing these taxes, including holding these investments for at least one year, harvesting losses to offset short-term gains, and limiting short-term gains (if possible) to tax-advantaged accounts.
  • Pay attention to basis. If you buy shares of stock or mutual funds at different times, you can minimize your gains when you sell a portion of your shares by selling the shares with the highest cost basis. To do that, you need to use the “specific identification method” and inform your broker which shares you wish to sell. If you don’t, the IRS will apply the first-in, first-out (FIFO) method, which often results in the lowest-basis shares being sold first, generating higher capital gains.
  • Avoid year-end mutual fund purchases. This is a common tax trap. Generally, mutual funds distribute capital gains and other income near the end of the year. If you invest in these funds shortly before the record date, you’ll be taxed on these distributions as if you had held the funds all year.

Tax season is an ideal time to consider these issues. An examination of your investment-related taxes for 2016 can reveal tax-saving opportunities for 2017. For more information please contact your Warady & Davis LLP advisor at (847) 267-9600 or visit our Wealth Management Consulting page to see how we can help.

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