Five Ways to Minimize a Higher Capital Gains Tax Rate

Vice President Kamala Harris has proposed a 28% capital gains tax on long-term gains — assets held for more than a year — for those making more than $100 million. The current top rate for long-term capital gains is 20%.

Their proposal would also increase the net investment tax (NIIT) from 3.8% to 5%. Under current law, NIIT applies to certain capital gains once modified adjusted gross income exceeds $200,000 for single filers or $250,000 for married couples filing jointly.

According to the Tax Foundation, the increases would bring the total federal capital gains tax rate to 33%, the highest since 1978. Additionally, many states have their own capital gains taxes or tax capital gains as income, such as New York, California and New Jersey. At both the state and federal levels, high earners with unrealized capital gains may face a significant tax bill.

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Of course, Harris' tax plan requires congressional approval, which could prove difficult. However, if you think you could be affected by higher capital gains tax, here are five ways we help our clients minimize long-term capital gains tax:

1. Aggressive tax collection

A proven method for minimizing capital gains tax is through tax loss harvesting. Tax loss harvesting involves selling a stock, bond, or mutual fund at a loss and then using that loss to offset a gain from another position in your portfolio. You can buy back the position you sold at a loss after 30 days to avoid the wash sale rule, or buy a similar security. The IRS allows investors to carry forward unused losses on their federal tax return indefinitely (state rules vary).

In practice, I find that many people wait until the end of the year to collect their tax losses or don't do everything at all. This is a missed opportunity. The investment programs we use can generate losses on a daily, sometimes even weekly basis. The idea is simple but powerful when implemented correctly.

We have had clients exit positions with large unrealized capital gains but pay very little federal capital gains tax simply because they had suffered several years of losses over time.

Make sure you're using a top-notch investment program for tax loss harvesting – it's a technology-intensive endeavor and not all providers are created equal.

2. Be even more aggressive about tax loss harvesting

Tax-loss harvesting doesn't just have to happen in bad years when inventories fall, but can also happen in good years. In his white paper “The Long and Short of It” in the Journal of Investments and Wealth Monitor, Hoon Kim of Quantinno Capital, a leading long/short tax loss provider, explains how a long approach can generate significantly more losses from a portfolio And Short stock strategy vs. long only strategy.

His approach is to expand an existing portfolio by borrowing and taking long and short positions on a new basket of securities. This gives Kim the opportunity to take losses in both good and bad stock market years. (Going “long” on stocks means profiting when they rise, and “shorting” means profiting when the underlying stock falls.) In some years, the losses caused were almost twice as great as a traditional long -Only tax loss harvesting strategy.

3. Harvesting capital gains

When harvesting capital gains, you sell your winners now to take advantage of a lower capital gains rate. There are two ways to do this. One option is to wait for your income to decrease, such as in retirement or when you are unemployed. If this is the case, your long-term capital gains rate could also be lower.

Or you can sell your winners now and pay capital gains tax at current rates. If you really believe interest rates are going up and you want to protect yourself, taking a few chips off the table is a sensible idea. In any case, it is worth knowing the tax rate for capital gains and planning accordingly.

4. Spread the payment over several years

If it's too painful to rip off the Band-Aid and sell everything at once, a phased sale can help. In a staged sale, an agreement is made to sell a predetermined quantity each year. This can help in two ways:

You spread your capital gains tax liability over several years rather than paying it all at once, which can be costly.
If your income fluctuates, you suffer a job loss, or something else happens that puts you in a lower tax bracket, you may pay lower capital gains tax in the longer term. Be aware that by delaying you are taking a risk – what has gone up in price may also fall.

5. Donate to charity

If you are interested in charitable causes, consider donating appreciated stock. If you give away appreciated stock to a charity, you can gift the stock without incurring any tax. I usually see this with clients who make a big profit on a single stock. They may not be willing to sell the shares due to capital gains tax. However, owning a large amount of a single stock can be risky. And if you're already donating cash to charities, why not donate some of the inventory?

There are different ways to give away shares. You may be able to donate directly to the charity, but I like to use a donor-advised fund, which is a great way to facilitate your donation and help with record keeping, which is a huge advantage when filing taxes.

If you're retired, you can use a charitable remainder trust (CRT). This is where you gift appreciated shares to the trust and avoid capital gains tax. The trust pays you an annuity – an annual source of income for a specified number of years. The remaining assets go to the charity.

There are other ways to minimize long-term capital gains tax. An older investor may well hold the appreciated stock until his or her death to benefit from the increase in basis (certain rules apply). That works too – as long as Congress or the next administration doesn’t change the rules.

Or if you're planning on moving to a more tax-friendly state for retirement, you may want to consider waiting to sell until after you move. Of course, in this position you could lose money while you wait, or the state could change its tax laws.

As you can see, there are many ways to reduce or eliminate long-term capital gains tax. But what makes sense for you really depends on your situation. Consider starting with a financial plan. A financial plan is a great way to look at things in their entirety and help you carefully consider your options.

You can arrange a free capital gain Tax audit with me here.

Michael Aloi, CFP, is an independent financial advisor with 25 years of experience helping clients achieve their financial goals. He works with clients throughout the United States. For more information, see www.michaelaloi.com.

Investment advisory and financial planning services are offered through Summit Financial LLC, an SEC registered investment advisor, 4 Campus Drive, Parsippany, NJ 07054. 973-285-3600 Fax. 973-285-3666.

This material is for your information and guidance and is not intended as legal or tax advice. Clients should make all decisions regarding the tax and legal implications of their investments and plans in consultation with their independent tax or legal advisors. Individual investor portfolios must be constructed based on the individual's financial resources, investment objectives, risk tolerance, investment horizon, tax situation and other relevant factors. Past performance is no guarantee of future results.

The views and opinions expressed in this article are solely those of the author and should not be attributed to Summit Financial LLC. Links to third party websites are provided for your convenience and informational purposes only. Summit assumes no responsibility for the information contained on third party websites. Summit's financial planning team has licensed attorneys and/or accountants to act solely in a non-representative capacity with Summit's clients. Neither they nor Summit provide tax or legal advice to their clients. The tax returns contained herein are not intended or prepared, nor may they be used, to avoid any United States federal, state or local taxes.

This article was written by and represents the views of our contributing consultant, not those of Kiplinger's editorial team. You can check the consultant documents with the SEC or with FINRA.

Five Ways to Minimize a Higher Capital Gains Tax Rate

ByVanessa

By Vanessa

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