Tax planning for mutual fund shareholders
EDITOR’S NOTE: This article is the second of a four- part series that pertain to yearend financial planning.
Prior to identifying those areas that can help you reduce your taxes regarding your mutual fund holdings, it is prudent to briefly review the IRS rules surrounding capital gains and losses, in general. If when comparing your realized (those securities sold or where the company has been purchased for cash by another company) gain with your realized loss, the net result is a loss, only up to $3,000 can be de- ducted from ordinary income. The balance can be carried forward, indefinitely. An additional component to consider prior to realizing a capital gain or loss in your portfolio is whether the transaction would trigger a long-term versus short-term capital gain/ loss. Long-term transactions are defined as those in which the underlying security has been held for one year or longer and are taxed at either zero percent for those taxpayers that are in the 10 percent to 15 percent marginal tax brackets or at 15 percent for those in the twenty- eight percent bracket. Short-term transactions, those which the security has been held for less than one year are taxed as ordinary income and subject to the same tax rate as your wages or dividend income. For most taxpayers, the rate is twenty- eight percent for the Federal Government. In both instances, for taxpayers in New York State, long-term and short-term capital gains are taxed as ordinary income.
Number one, call your mutual fund and ask them if they are planning any year- end distributions. Keep in mind that capital gains declared by mutual funds are taxable regardless of whether you receive them in cash or reinvest in additional shares. Furthermore, there is no economic benefit to the distribution. It is the same as getting four taxable quar- ters in return for your non-taxable one dollar bill. Upon calling, should you learn that your mutual fund is intending to declare a capital gain, find out how much it will be on a per share basis and on what date it will be declared. This information will help you determine what steps, if any, need to be taken in order to minimize the impact of this declared gain.
Second, swap the mutual fund in which you have a taxable loss for a similar fund. Please note that your adjusted tax basis consists of your initial contribution to the fund plus any subsequent out- of-pocket contributions as well as any reinvested dividends or capi- tal gains declared during prior calendar years less any withdrawals. Regardless of what others might say to the contrary, given the fact that there are over eight thousand mutual funds to choose from, there is always an appropriate alternative to your current fund. Do not think that your fund is “the best” or “one of a kind.”
Be certain to check with your tax advisor prior to making any year- end portfolio transactions.
Good luck, pruning your portfolio for tax savings makes dollars and cents.
Please note that all data is for general information purposes only and not meant as specific recommendations. The opinions of the authors are not a recommendation to buy or sell the stock, bond market or any security contained therein. Securities contain risks and fluctuations in principal will occur. Please research any investment thoroughly prior to committing money or consult with your financial advisor. Please note that Fagan Associates, Inc. or related persons buy or sell for itself securities that it also recommends to clients. Consult with your financial advisor prior to making any changes to your portfolio. To contact Fagan Associates, please call 518-279-1044.