This article is original content written by Manchester, CT Financial Advisor Thomas Scanlon, CFP®, CPA
Year to Date Returns
Its late fall here in Connecticut. Soon we will celebrate Thanksgiving. Investors certainly have a lot to be grateful for this year. The markets (so far) have been kind to investors in 2019. Through November 12, 2019, the Standard & Poor’s 500 Index has returned 23.3%. (1) That’s quite a year.
Oh, and there are a little under two more months to go.
Capital Gains Distributions and Tax Rates
Many mutual funds will pay out a capital gain distribution. In 2018, 86% of all U.S. equity mutual funds paid a distribution. Of those that paid a distribution, the average capital gains distribution was 11%. (2) This is typically done towards the end of the year. This is taxable income to the investors in these mutual funds. Some mutual funds have lower capital gains distributions and therefore are considered more tax efficient, others have higher capital gains distributions and therefore are considered less tax efficient.
Capital gains distributions, along with other capital gains transactions are subject to capital gains taxes. Short-term capital gains, which is for sales of capital assets held less than a year, are taxed at your ordinary income tax rate.
For long-term capital gains tax, which is for sale of capital assets held longer than a year, there are five different rates of capital gains taxes as follows:
> The 0% rate applies if your income is very modest
> The 15% rate is the predominate rate many investors will pay
> The 20% rate applies if your income exceeds a certain threshold
> The 25% rate applies for certain real estate
> The 28% rate applies to small-business stock and collectibles
Net Investment Income Tax
In addition to the capital gains tax, investors may be subject to the Net Investment Income Tax (NIIT). This tax is applied to interest, capital gains, dividends, passive activities and rental and royalty income. The rate on this tax is 3.8% if the income is above certain thresholds. This threshold is having modified adjusted gross income of over $200,000 as a single filer and $250,000 as married filing jointly.
Wash Sale Rule
Investors need to be aware of the so-called Wash Sale Rule. This is an income tax rule regarding sales of capital assets at a loss. A wash sale occurs when a capital asset is sold for a loss and then this asset is purchased within 30 days or it was purchased 30 days prior to the sale. The wash sale is not allowed as a capital loss. When selling securities for a loss, it is important to be cognizant of this rule so as to minimize or eliminate and wash sales that are not income tax deductible.
Capital Loss Carryover
For income tax purposes, capital gains and losses are netted out. If the net amount is a capital loss, the most that can be deducted in any tax year is $3,000. Any capital losses above this amount are carried over into future tax years and can be offset with any capital gains.
It’s important to review your portfolio and mutual fund holdings. To the extent there are capital losses that can be recognized, it may be appropriate to sell these positions to offset any other capital gains or capital gains distributions.
It is important for investors to be aware of all of the income tax strategies investors can avail themselves to.
Having said that, it’s important not to let the tax tail wag the dog.
- Wall Street Journal – November 13, 2019
- Russell Investments – September 15, 2019