Methods for Tax Avoidance and Financial Savings

Many financial advisors discuss applicable tax issues with their clients as the year comes to an end. Some of the most often used methods for financial savings and tax avoidance are below:

Avoid Buying a Distribution: Identify which of your client’s mutual funds will make year-end capital gain distributions. The client will be liable for tax on the distribution if the client owns the fund on the record date. If the client buys after the record date, however, they will not be liable, so clients may want to wait to buy certain funds to avoid tax liability.

Loss Harvesting: A client should consider harvesting a loss if he or she would receive a lower gain by selling a fund prior to the record date than he or she would receive from the distribution. Even if the fund pays no distributions, a client may still harvest a loss. However, a client can only use $3,000 of losses against ordinary income, and harvesting a loss will reset cost-basis to a lower amount, increasing future gains.

Gain Harvesting: Lower tax-bracket clients will generally benefit more from gain harvesting than loss harvesting. Long-term capital gains and qualified dividends that fall inside the 10% or 15% brackets have a federal income-tax rate of 0%. A client can sell and immediately buy back the same security and decrease future gains by effectively stepping up the basis.

Taking or Converting Retirement Money: Retirees with large retirement accounts may benefit from getting taxed at 10% or 15% for retirement money because future RMDS will decrease. Clients who have not turned 70 ½ may want to consider converting distributions from retirement accounts or distributions in excess of the RMD to a Roth. Roths are not subject to RMDs and the client will pay nothing on the ultimate rate. Clients who turned 70 ½ this year must decide whether to take the 2011 RMD distribution now or wait until the first-year extension date of April 1, 2012.

Gift-Giving: Clients can take advantage of the current $13,000 annual exclusion, $5 million gift tax exclusion, and zero long-term capital gains rate by gifting large sums to relatives. By involving numerous family members, the transferred amount can exceed six figures without using any of the givers’ $5 million exclusion.

See Dan Moisand, Year-End To Dos, Financial Advisor, Nov. 9, 2011.

Special thanks to Jim Hillhouse (WealthCounsel) for bringing this article to my attention.