For those doing tax this year, sifting through multitudinous tax rules can be a tedious task. Pitfalls are there and if you are not careful enough, you may even be paying fines for simple mistakes. To avoid them, keep the following in mind:
1. Offset Gains with Losses
Capital gains tax is charged for selling an investment with a profit. On the other hand, if you sell a losing investment, you won’t be charged of any tax liability. The catch is, you can actually offset your gaining investments with your losing ones to reduce your tax. Say, you have investment in stocks. One is gaining, the other one losing. If you sell the gaining one, you would pay a corresponding tax. In order to reduce this, you better sell also your losing investment. This effectively offsets the tax payment. This is a good option from tax standpoint. One thing to bear in mind, however, is the rule on wash sales. It says that if you repurchase your losing stock within thirty days, you are not allowed to deduct your loss.
2. Properly Calculate the Cost in Mutual Funds
If you have stocks, you compute your gain with the difference of the selling price and acquisition cost net of commissions and other charges. It gets complicated when you invest in mutual funds, which is most likely a collection of various individual stocks and government securities. In calculating basis for mutual funds, be sure to factor in dividends and capital gains you were able to reinvest in the fund. Taxing authorities consider them taxable distributions already the moment they are earned, thus, you already paid taxes for them. Failing to add these items in your basis makes you report a much larger gain than what supposed to be reported. This leads to payment of excess taxes.
3. Don’t Miss Deadlines
There are outstanding retirement plans like Roth IRAs and Keogh Plans. They help you stretching your dollars and prepare for your future retirement. Some plan holders, however, blew off this opportunity by failing to make contributions regularly and on time. Beating the applicable IRS deadlines is necessary that these dates must be marked in the calendar. It’s December 31st for Keogh plans and for IRA is April 15th of the following year.
4. Put your Investments in the Right Account
Holding investments in the right account can make one generate savings that could reach even a thousand bucks in unnecessary taxes. Investors usually have two types of accounts: traditional and tax-advantaged. Investments producing taxable income and short-term capital gains must be put in tax-advantaged account. On the other hand, if the capital generates long-term capital gains and dividends, better put them in traditional account. As example, we have corporate bonds and treasury securities. They produce a steady, regular stream of interest. Unlike dividends, this income does not qualify under special tax treatment. Eventually, you need to pay taxes on them. It is a sound judgment to place them in tax-advantaged accounts for it allows you to defer payments of taxes in the future.