The Republican Party was successful in pushing through a sweeping tax overhaul at the end of last year, which has since pushed the stock market to new record highs.
As investors assess portfolio gains accrued over the past few years of this extended bull market, they may want to take note of how the new tax laws can impact future profits.
Strategies that have worked in prior years, for example, may no longer be applicable.
“The tax code is written to the IRS’ advantage, but if we’re smart about it and we plan, we can make it [work] to our advantage,” Elijah Kovar, co-founder of Great Waters Financial, told FOX Business. “These changes don’t have to hurt anyone … If you’re forward-looking and you’re thinking of multiple years at one time.”
The long-term capital gains tax still applies to the profits made on assets held for more than one year, at rates of 0%, 15% or 20%. Instead of these three rates applying to different tax brackets as the previous law called for, they are now applied to different income thresholds, which coincidentally, maintain rates at essentially the same levels for taxpayers.
0%: Single filers with incomes up to $38,600
0%: Married couples filing jointly with incomes up to $77,200
15%: Single filers with incomes between $38,601 and $425,800
15% Married couples filing jointly with incomes between $77,201 and $479,000
20%: Single filers with incomes over $425,801
20% Married couples filing jointly with incomes over $479,001
Short-term capital gains, or profits on assets held for less than one year, are taxed the same way as your regular income. That means, if your tax bracket shifted under the new bill, then this rate changed. For some people, this could result in bigger profits if you’re paying less under the new bracket layout, though you’re likely to pay even less if you hold onto the asset for more than a year.
The net investment income tax, a 3.8% Affordable Care Act tariff that applies to certain taxpayers, is still in effect. The IRS has guidelines on who owes this additional tax.
Capital loss deduction
This is a deduction that allows investors to mitigate some of the losses incurred on investments. If you have capital gains and capital losses, you first have to offset some of your gains with those losses – though long-term gains can only be offset by long-term losses. If the losses outweigh the gains during a given year, you can use up to $3,000 to reduce your adjusted gross income. The maximum amount an investor is allowed to deduct in capital losses is $3,000, which is consistent with the previous law.
If your yearly losses exceed $3,000, you can carry them over to the following year.
Capital gains tip
There are key years after retirement, and before people start receiving Social Security benefits, Kovar said, when taxpayers can take advantage of low capital gains rates. Oftentimes during this period, people will have lower income and can cash in a lot of their capital gains at the 0% rate, he said.
Investment expense deduction
Under the previous law, investors were allowed to deduct the cost of some fees paid to managers and brokers. However, along with many itemized deductions, the new tax law did away with that. Fees paid for tax-prep are also no longer deductible.
Kovar notes that you can still deduct the expense if the manager is giving advice only, though most people are paying their financial adviser to manage their money. However, your adviser may be able to get creative and help you out on this one, so it’s worth asking about.
One way Kovar is helping his clients navigate the new tax system is by advising some to contribute to a donor-advised fund. There are multiple benefits to doing so under the new tax code, which include potentially avoiding the capital gains tax and taking advantage of the charitable deduction.
Taxpayers have the option of stashing as many years’ worth of charitable donations as they can afford to in a donor-advised fund. Those funds can then be given away at the investors’ leisure, but taxpayers will reap the benefits of the charitable deduction up front.
This strategy is particularly useful for people who are not itemizing, but still want to give to charity. While the standard deduction has nearly doubled, making it more economical for most people, transferring cash into a donor-advised fund can lend itself well to a bunching strategy, which allows taxpayers to take advantage of the standard deduction some years, while itemizing in others.
He noted investors can also donate highly-appreciated stock to the fund, get the write-off on their taxes and avoid paying the capital gains tax. Since the fund is a non-profit, when it sells the stock it will not have to pay income or capital gains taxes, either.