The Taxes We Pay are Just as Important as the Returns We Earn

Right after the end of each calendar year, we receive our investment statements which show how we performed for the full year. We may make a mental note, compare last year’s performance, refer to our plan, or various other items to make sure we are on track. If we have a retirement account such as a 401k, IRA or other qualified plan, that’s pretty much the end of the story, unless we need to manage for withdrawals. However, if we have nonqualified accounts that are not protected from tax deferrals such as brokerage, stocks, or even bank savings accounts, it can only be part of it.

After a month or two goes by, we start receiving something called our 1099’s. It shows purchases and sales, any interest or dividends earned (regular or qualified), and short or long-term capital gains that occurred. These various amounts are all reportable for income taxes, unless the interest is tax exempt. So, in theory, the returns we earn should be reduced by the amount of tax we pay if we are seeking to accurately portray how we are doing along the way. That’s where we stand.

Here are the rules: interest, ordinary dividends and short-term capital gains are taxed as ordinary income rates. Qualified dividends and long-term capital gains are taxed at capital gains rates. Municipal bond income can be tax exempt either both federal and state, or just federal, depending on the residency of the investor. Yep, it gets confusing.

So. Now what? First and foremost, it is important to know the rest of the story regarding the investor and income taxes. Second, we believe it is important to use tools which are as tax efficient as possible, as well as focusing on the lowest specific tax output. For example, if an investor is in a higher income tax bracket, tax exempt income, long-term capital gains and qualified dividends may be a focus. If there is concentration in employer stock, we may need to decide when to sell each specific share and account for basis. If we see charitable inclination, we may be able to donate highly appreciated assets and remove the liability altogether. The point is the taxes we pay and planning we do are just as important as the return we earn on our money.

In closing, we have many clients with non-qualified accounts which need to be managed in a tax-efficient manner. We use many tools to help gain the best return with the least amount of tax outlay. From what we see out there, planning in this area often gets overlooked, and we are happy it is one of our specialties.

Investing involves risk. No investment strategy can guarantee positive results. Loss, including loss of principal, may occur. Material discussed is meant to provide general information and it is not to be construed as specific investment, tax or legal advice. Keep in mind that current and historical facts may not be indicative of future results. Diversification is an investment strategy that can help manage risk within a portfolio, but it does not guarantee profits or protect against loss in declining markets.

This content is developed from sources believed to be providing accurate information. The information in this material is not intended as tax or legal advice. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security. (C) Twenty Over Ten