During 2008 — for the first time — many middle-income earners are able to harvest certain gains and pay no taxes.
Posted: Sunday, August 10, 2008 7:00 pm
Save this column. I’m convinced that your taxes will never be as low as they are this year. Presidential campaign promises are all about “change,” new programs and new entitlements. Moreover, the House and Senate majorities have already passed five-year budget outlines that will allow the Bush tax cuts to expire at the end of 2010. Tax increases are virtually inevitable.
That’s why you must show this column to your tax preparer. Ask for what-if calculations, to see if you might benefit from my “harvest” strategies.
Usually when farmers start mentioning their crop prospects, I write a column sharing tax-management strategies that could be completed by year end. A recurring theme is the harvesting of investment losses to offset capital gains, which shrinks taxable income. But during 2008 — for the first time — many middle-income earners are able to harvest certain gains and pay no taxes.
Opening the zero-tax window could save you a bundle. Readers are still requesting copies of earlier columns that explained this strategy, so here’s a recap.
From 2008 through 2010, the tax rate on dividend income and capital gains from the sale of investments held at least a year in taxable accounts drops to zero for the two lowest — 10 or 15 percent — federal tax brackets. To qualify for the exemption, a married couple filing jointly is limited to taxable income below $65,100. For a single tax filer, the cutoff is $32,550.
People with higher income may be able to take advantage of the zero tax rule by reducing their taxable income by itemizing deductions such as mortgage interest and charitable donations, or by making maximum contributions to sheltered employer-sponsored plans or IRA accounts.
This is a can’t-miss opportunity to lock in profits on highly-appreciated stocks or mutual funds. Yet you might want to delay taking gains until late November, when mutual funds estimate their yearly capital-gain and dividend distributions. An accountant can guesstimate when harvested gains might push your income into the 25 percent tax bracket, where the tax rate is 15 percent. A larger slice of Social Security benefits could also be taxable. One tactical idea: Spread your tax-free harvesting over the entire three-year period.
Harvesting losses during a correction can be a key strategy. Purposely taking a loss on a floundering stock during a bearish market may seem counterintuitive: Especially if the company pays a good dividend, you’ll be tempted to hang on to losers, hoping for a turnaround.
But a two-step strategy solves that problem: First you would harvest the “capital” loss, as a way to offset capital gains. Then, immediately buy back this stock — and hold on.
Pay off credit-card debt before stashing your cash. If you must flee market volatility, it makes no sense to move money into regular savings accounts, CDS or money-market accounts earning just enough to outpace inflation, unless you’ve paid down or paid off card debt that’s costing you 15 percent interest or more.
Laddering is a simple sleep-well strategy. I see no reason to flee into fixed-income investments when the equity market is stumbling. In fact, when a bull market begins (I suspect one already has), major stock gains can occur suddenly, over a period of just a few days.
Yet I understand why many retirees, and those soon to retire, move into conservative certificates of deposit during a market correction. Although rates being paid on CDS are relatively low, you do know what the return will be. And the certificates are FDIC-insured.
So if you feel you must flee market risk, to protect your principal, do an online search of sites such as bankrate.com to comparison shop: A local bank or credit union may be competitive. Your goal is to find just one financial institution that’s paying a high APY (annual percent yield) on maturities that might give comfort from the storm.
Consider a “ladder” of CDS, with maturities ranging from six months through two years, perhaps longer when significant extra yield can be captured. With money spread evenly across a range of maturities, you’ll be using an idea I think of as “time diversification.” And since you reinvest only a portion of savings at any time, this strategy offers a more predictable — and flexible — stream of income.
If you have a Lessons Learned topic to suggest, you can call Gene Kelly at 421-2861, write to him at 2611 Bretigne Circle, Lincoln 68512, or e-mail him at genekelly@windstream.net.