In this series, we already discussed ways to make the most of your retirement savings plans from a tax perspective. Now we’ll cover some other specific strategies for your investments, Social Security benefits and Medicare.
Capital Gains and Losses
Looking at your investment portfolio can reveal a number of different tax-saving opportunities. Start by reviewing the various sales you have realized so far this year on stocks, bonds and other investments. Then review what’s left and determine whether these investments have an unrealized gain or loss. (Unrealized means you still own the investment and haven’t yet sold it, versus realized, which means you’ve actually sold the investment.)
Know your basis. In order to determine if you have unrealized gains or losses, you must know the tax basis of your investments, which is usually the cost of the investment when you bought it. However, it gets trickier with investments that allow you to reinvest your dividends and/or capital gain distributions.
Consider loss harvesting. If your capital gains are larger than your losses, you might want to do some “loss harvesting.” This means selling certain investments that will generate a loss. You can use an unlimited amount of capital losses to offset capital gains. However, you are limited to only $3,000 of net capital losses if married filing jointly ($1,500 if married filing separately) that can offset other income such as wages, interest and dividends. Any remaining unused capital losses can be carried forward into future years indefinitely.
Be aware of the “wash sale” rule. If you sell an investment at a loss and then buy it right back, the IRS disallows this deduction. The “wash sale” rule says you must wait at least 30 days before buying back the same security in order to be able to claim the original loss as a deduction. The deduction is also disallowed if you bought the same security within 30 days before the sale. However, while you cannot immediately buy a substantially identical security to replace the one you sold, you can buy a similar security—perhaps a different stock in the same sector. This strategy allows you to maintain your general market position while utilizing a tax break. (For related reading, see: How to Avoid Violating Wash Sale Rules When Realizing Tax Losses.)
Sell worthless investments. If you own an investment that you believe is worthless, ask your tax preparer if you can sell it to someone other than a related party for a minimal amount, say $1.00, to show that it is, in fact, worthless. The IRS often disallows a loss of 100% because they will usually argue that the investment has to have at least some value.
Always double check brokerage firm reports. If you sold a stock in 2016, your brokerage firm reports the basis on an IRS Form 1099-B in early 2017. Unfortunately, sometimes there could be problems when reporting your information, so we suggest you double-check these numbers to make sure that the basis is calculated correctly and does not result in a higher amount of tax than you need to pay.
In 2016, a 3.8% Medicare surtax on net investment income remains in place for wealthy taxpayers. The 3.8% Medicare surtax is on top of ordinary income and capital gains taxes, meaning long-term capital gains and qualified dividends may be subject to taxes as high as 23.8%, while short-term capital gains and other investment income (such as interest income) could be taxed as high as 43.4%.
The Medicare surtax is imposed only on net investment income and only to the extent that total modified adjusted gross income (MAGI) exceeds $200,000 for single individuals and $250,000 for taxpayers filing joint returns. Not all income is subject to this Medicare tax. For example, interest and dividends are included but wages are not. Check with your tax preparer if you are subject to this tax. (For related reading, see: New Taxes Under the Affordable Care Act.)
Taxation of Social Security Income
Social Security income may be taxable, depending on the amount and type of other income a taxpayer receives. If a taxpayer only receives Social Security income, this income is generally not taxable (and it is possible that the taxpayer might not even need to file a federal income tax return).
If a taxpayer receives other income in addition to Social Security income, then up to 85% of the Social Security income could be taxable. There is a “floor” ($32,000 married filing jointly; $0.00 married filing separately; $25,000 all other taxpayers) whereby a portion of Social Security benefits become taxable and the 85% inclusion kicks in once provisional income goes above a “ceiling” ($44,000 married filing jointly; $0 married filing separately; $34,000 all other taxpayers). For married taxpayers filing a joint return and for married persons filing separately who do not live apart from their spouses for the whole year, the provisional income threshold is $0.00. A complicated formula is necessary to determine the amount of Social Security income that is subject to income tax. We suggest using the worksheet in IRS Publication 915 to make this determination.
Finally, it is important to note that Social Security income is included in the calculation of modified adjusted gross income for purposes of calculating the 3.8% Medicare surtax on net investment income (as discussed earlier). Therefore, taxpayers with significant net investment income might have more reason to defer Social Security benefits.
Remember—every situation is different and not all strategies will be appropriate for you. Please discuss all tax strategies with your tax preparer prior to making any final decisions. And stay tuned for part three in our series, which will look at itemized deductions, charitable giving and other tax planning strategies. (For related reading, see: Don't Forget the Importance of an Estate Plan.)
Michael L. Schwartz, RFC, CWS, CFS, a registered principal offering securities and advisory services through Independent Financial Group, LLC Member FINRA-SIPC. Schwartz Financial and Independent Financial Group are unaffiliated entities. The views expressed are not necessarily the opinion of Independent Financial Group, LLC and should not be construed, directly or indirectly, as an offer to buy or sell any securities mentioned herein. This article is for informational purposes only. This information is not intended to be a substitute for specific individualized tax, legal or investment planning advice as individual situations will vary. For specific advice about your situation, please consult with a financial professional.