How to coordinate trading strategies and tax strategies before the end of 2023
As we approach the end of 2023, the filing of 2023 taxes will be coming around sooner than we realize. Because tax regulations change frequently, it is also critical to seek personalized advice from a tax professional or advisor. However, this article is designed to provide you with some insights into potential capital gains taxes (and other applicable taxes related to trading), tips for minimizing capital gains taxes on investment profits, and what can still be done in 2023 to optimize your tax incomes when filing in April of 2024. Don't forget to also check out Schaeffer's Tax Day Primer: How Options Trading is Impacted.
What do I need to know about capital gains taxes and other taxes on investment income?
We already know short-term capital gains are taxed at ordinary income tax rates. Recently, we chatted with Michael Ryan, a 30-year veteran of the financial markets, about long-term capital gains tax. Here's the scoop he gave us, "Picture this: In 2023, if you've held onto your investments like a treasure, you're looking at capital gains taxes of 0%, 15%, or a hefty 20%, all based on what you rake in annually. Flying solo? You're in the clear with 0% tax up to $44,625. Earning more? The meter ticks up to 15% until you hit $492,300, then it's 20% territory. Married? Double the fun with 0% tax up to $89,250, and the same 15% and 20% steps follow at higher income levels."
Another tax factoid to consider when filing 2023 taxes is Net Investment Income Tax, or NIIT. According to Kathryn Kubiak-Rizzone of About Time Financial Planning, "NIIT is an additional 3.8% surtax that's added to a person's long-term capital gains tax rate when their income is higher than a certain threshold. This brings their total long-term capital gains tax rate to 18.8% or 23.8%. The NIIT comes into play for married couples filing jointly once they make more than $250k in adjusted gross income (AGI). People who file as single or head of household are subject to NIIT once their AGI exceeds $200k, and married couples filing separately face NIIT with an AGI above $125k."
It's noted by Steve Griffin, CEO of Madison Avenue Technology, that the NIIT "was implemented as part of the Affordable Care Act and is still in effect for 2023. To determine if you will be subject to this tax, you can use the IRS's Net Investment Income Tax Estimator tool."
The Net Investment Income Tax was designed to help fund Medicare. According to Linda Chavez of Seniors Life Insurance Finder, "To determine if you will be subject to the NIIT, you must meet two criteria: 1) have a modified adjusted gross income (MAGI) above a certain threshold, and 2) have net investment income. The thresholds for the NIIT in 2023 are $200,000 for single filers and $250,000 for married filing jointly,". Additionally, Chavez says, "If your MAGI is above the threshold and you have net investment income, you will be subject to an additional 3.8% tax on your investment income."
What are the best tips for minimizing and/or avoiding capital gains tax for 2023 filings?
Strategic planning and staying abreast of current tax laws are crucial for effectively managing capital gains tax liabilities according to investor, Matt Haycox. Haycox's top recommendations for managing the impact of capital gains taxes include utilizing tax-loss harvesting to offset gains, investing in tax-advantaged accounts like IRAs or 401(k)s, and holding investments longer to qualify for lighter long-term capital gains rates.
Another overlooked investing technique, according to Kubiak-Rizzone, that can greatly minimize capital gains tax is "to invest in exchange traded funds (ETFs) instead of mutual funds in a taxable brokerage account. For buy-and-hold investors this is especially important. The reason for this is something called capital gains distributions. You generally only have to pay capital gains tax when you sell an investment. But with mutual funds, any capital gains that are realized within the fund itself - from the fund manager buying and selling within the fund throughout the year - are passed through to the investor, even if they just held onto the mutual fund the whole year! A couple years ago, some holders of Vanguard's target date mutual funds were blindsided by this, especially because Vanguard's founder, Jack Bogle, is known for promoting a long-term buy-and-hold approach. ETFs are similar to mutual funds in that they invest in a basket of securities, but different because they don't pass along any capital gains distributions to their investors. This makes ETFs a much more tax-efficient choice to hold in taxable brokerage accounts."
Forrest Baumhover of Teach Me! Personal Finance also recommends that you take a look at tax loss harvesting opportunities for 2023. If no such opportunities currently exist, commit to discussing your investment situation with a professional for the 2024 tax year when you have more time to incorporate tax planning as part of your overall financial plan.
What can traders do before the end of 2023 to minimize tax blowback when filing their 2023 taxes?
According to Zachary Hellman, owner of Tax Prep Tech, there are four year-end tips for investors/traders:
- Assess Portfolio: Review your investment portfolio for any opportunities to harvest tax losses.
- Balance Gains and Losses: Consider selling some investments at a loss to offset gains.
- Maximize Retirement Contributions: Contributing to tax-deferred retirement accounts can reduce your taxable income.
- Plan for Distributions: Be mindful of any mutual fund distributions and their potential tax impact.
Also, it's critical to note the changes in capital gains tax rates from 2022 to 2023 due to income tax bracket changes, according to Hellman. "The top of the 0% bracket increased from $41,675 in 2022 to $44,625 for single filers and from $83,350 to $89,250 for married filing joint filers. The rate became 20% after $459,750 in 2022 to $492,300 for single filers and went rom $517,200 to $553,850 for married filing joint filers, " says Hellman, "The income thresholds for these rates are typically adjusted for inflation each year."