Year-end tax planning for shareholders of mutual funds & charitable giving

This article is the second of a three part series appearing in The Record, The Saratogian and Community News that pertains 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 deducted 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 zero percent for those taxpayers filing individually with taxable income under $39,375 and for those filing jointly with taxable income under $78,750; at 15% for those filing individually with taxable income of between $39,375 and $434,550 and for those filing jointly with taxable income between $78,750 and $488,850. For those filers fortunate enough to be above those levels, the federal long-term capital gain tax rates are 20%.

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-two percent for the Federal Government. In both instances, for taxpayers in New York State, longterm 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 quarters 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 capital 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!

Charitable Giving

In our opinion the most obvious and effective way to give to a charitable organization is through a gift of appreciated stock. This is a win-win situation for both the taxpayer and the charity. The taxpayer can deduct the market value of the stock on the date of the gift and the charity gets the donation. Furthermore, by donating the appreciated stock rather than selling the stock and donating the cash proceeds, the taxpayer also avoids any capital gains tax.

Please note that this only will work with appreciated securities within taxable accounts. Should you hold a stock that has depreciated in value, it is generally wise to sell the stock and donate the cash proceeds. Utilizing this method, the taxpayer can write off the capital loss up to current IRS limitations.

Readers will note that the above paragraph does not pertain only to appreciated stock, but rather to all appreciated assets, including bonds, mutual funds and real estate.

The Pension Protection Act of 2006 allows taxpayers age 70 ½ to exclude from adjusted gross income qualified charitable contributions up to $100,000 per year from either a traditional or Roth IRA. Prior to the passing of this legislation, a taxpayer would have to first withdraw the money from his IRA and then make the contribution. Many times this withdrawal resulted in the taxation of the Social Security Benefits of the taxpayer, reductions in property tax assistance and reductions in other government sponsored programs.

This law allows the taxpayer to circumvent this step thereby eliminating the prior pitfalls noted in the preceding sentence. Additional benefits to rolling over the IRA distribution directly to a qualifying charity is that this donation qualifies toward the owner’s minimum required distribution, but does not count toward the IRA owner’s maximum 50% cash contribution limit as a percentage of their adjusted gross income.

One final way to get into the charitable giving mood this holiday season is through gifts of life insurance policies. To accomplish this transfer, the current owner must name the qualified charitable as either the new owner or the irrevocable beneficiary. If the owner does one of these then he/she is able to obtain a tax deduction on the present value of the insurance contract or his/her accumulated premium payments, whichever is higher.

As always, please be sure to check with your tax advisor prior to making any sizable charitable contributions.

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) 2791044.