Selling triggers taxes, but investors can trim the amount they pay to Uncle Sam with some tax-wise planning. Here are five things you need to know:
1. Capital-gains rates for the wealthy are up. The tax rate on profits from assets held more than one year jumped from 15% in 2012 to 23.8% in 2013 for singles with adjusted gross income of $400,000 or more ($450,000 or more for married couples). Single investors with AGI of $200,000 to $400,000 and married couples with AGI of $250,000 to $450,000 are also paying more, at an 18.8% rate. Advice: If your income approaches one of these thresholds, figure the tax hit before triggering gains. Taking gains in years in which you have less income or more deductions could save a bundle.
2. Short-term sales will cost you. If you sell a security you’ve held for a year or less, you’ll pay taxes on the profits at ordinary income tax rates, which run as high as 39.6%. If you’re in the top tax brackets, you’re also subject to the 3.8% Medicare surcharge, making the top effective rate on that gain a whopping 43.4%. Advice: Unless you have capital losses to offset costly short-term gains, try to hang on to your winners for more than one year.
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3. You get a break on company stock in a 401(k). Most money that comes out of retirement plans is taxed at ordinary income tax rates. But there’s an exception for employer stock in these plans. If you take a lump-sum distribution of the employer shares, you are taxed (at ordinary income rates) only on your “basis”—what you paid for the shares. You will pay tax on the appreciation when the shares are sold, but at gentler capital-gains rates. If you rolled the shares into an IRA, you’d wind up paying taxes on that appreciation at ordinary income tax rates when the money came out of the IRA. Advice: If you have the option, this is a simple way to permanently lower the tax rate on some retirement savings.
4. Your heirs get a break on taxable accounts. When you die, the tax basis of assets in a taxable account gets “stepped up” to the current market value. So, when your heirs sell, they won’t owe tax on appreciation that occurred during your lifetime. By contrast, there’s no step-up for money in tax-deferred accounts, such as 401(k) plans and traditional IRAs. Your heirs will pay tax at their top brackets when they withdraw funds. Advice: Watch how you drain your accounts. Use taxable accounts to sell stocks at a loss or modest gain, leaving alone securities with big gains. Take the rest from the tax-deferred accounts, which have mandatory distribution requirements for those who are over 70½.
5. Charities love stock donations. Most charities are happy to take your appreciated stock in lieu of cash. You get a deduction for the current value of the stock if you have owned it for more than a year. The charity gets the shares to sell, but because it’s a tax-exempt organization, it’s not subject to capital-gains taxes. Advice: Look at the stocks in your taxable accounts to find those with the greatest appreciation and consider using those shares to fund charitable gifts.
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