Capital Gain Tax Mitigation in Investments


August 8, 2017

You don’t like to pay taxes. Nobody likes to pay taxes! Like most people, you probably dread the month of April because you have to deal with the hassle of taxes, and you may be wondering if there are ways to pay less. One of the things to learn more about is capital gain tax mitigation in investments.

Long-term investors have historically benefitted in several ways, including:

    • positive performance, and
    • under current tax codes, taxes for gains on long-term holdings (defined by the IRS as being held more than one year) are substantially lower than the tax rates for short-term gains. Long-term gains can be untaxed in certain limited situations with a maximum rate of 20% for the highest earners. (excluding any Affordable Care Act taxes[1][2])

So once again patience, as we mentioned in our earlier blog post, has historically paid off for those that stick with a diversified portfolio of stocks through thick and thin. While we occasionally hold some stocks for a shorter period of time, our newsletter recommendations include an average holding period of 6.3 years (through 06.30.17).

Dividends & Taxes

Dividends, dividends and more dividends. It seems that everywhere we look these days, we find investment professionals singing the praises of dividends. And why not? Interest rates have risen at an anemic pace and remain far below the long-term historical averages, while the yield on the S&P 500  approaches or exceeds many of the U.S. Treasury bonds[3]. But what do dividends have to do with capital gain tax mitigation in investments?

As outlined by the IRS[4], qualified dividends are ordinary dividends subject to the same 0%, 15%, or 20% maximum tax rate that applies to net capital gains. To qualify for these maximum rates, the following requirements must be met:

The dividends must have been paid by a U.S. corporation or a qualified foreign corporation.

The dividends are not of a type categorized as “not qualified” by the IRS.

You meet the 60-day holding period for common stocks or the 90-day holding period for preferred stock.

Please check with a qualified tax professional if you have questions regarding your dividends and whether they are qualified or nonqualified.

In our view, the potential tax advantage of dividend payments is an added bonus to the strong long-term returns of dividend-paying stocks. Over time, these have outperformed non-dividend-paying stocks by about 2% on an annualized basis.

tax advantage dividend paying stocks

 

We think that the lower-tax-rate rhetoric coming from Washington makes a tax rate increase on dividends unlikely in the near term. For the many people that hold dividend-paying stocks in retirement accounts, the income tax consideration may not currently be relevant. However, future retirees might be interested in the lower volatility that dividend-payers tend to exhibit over time (measured by standard deviation).

dividend paying stocks

 

That said, we offer this reminder: the numbers we’ve crunched using portfolios created by Professors Eugene Fama and Ken French indicate that dividend-paying stocks have actually delivered plenty of capital appreciation to go along with the generous income streams they provide. As the chart below shows, the higher the yield, the higher the long-term return (past performance of course being no assurance of future performance).

higher yield dividend paying stocks

 

Tax Loss Harvesting

There is yet another way to attempt to mitigate taxes. Tax loss harvesting is where you sell some of your stocks that are trading at a loss in order to help  offset the gains you  would be taxed on. Due to the wash rule, you must wait at least 31 days before repurchasing the stock. For example, if your portfolio has 3 stocks with a net gain of $10,000 and 2 stocks with a net loss of $8,000, then you are only taxed on $2,000. You can also substitute a stock that has similar characteristics (or any stock) to the stock you sold for tax loss harvesting, which eliminates the 31-day wait to buy back the stock.

Summary

Yes, this can get complicated quickly. As a high net worth individual, you probably have a solid accountant that helps you navigate these waters. Use the content above to spur discussions with your tax professional to explore new ways to minimize your tax burden. But be careful to not fall into a trap of buying or selling in pursuit of tax policy and at the expense of solid investing principles. We believe one of the most important things we do for clients is to keep them on the path.

Investment optionsThis report explores various investing options and some of their pros and cons. As your portfolio grows, options become available that may not have been when you first started investing. An investment plan and firm that worked for you when you were 30 may not be a good fit for you when you’re 50.

Download Investment Options Report

[1] https://www.irs.gov/uac/newsroom/net-investment-income-tax-faqs

[2] Your long-term capital gains tax rate depends on your marginal tax rate, or tax bracket. Once you know your marginal tax rate for your income level and tax filing status, you can match it to your long-term capital gains tax rate. The zero percent tax rate on capital gains applies to people in the 15% marginal tax rate or below. In 2017, that applies to married tax filers with taxable income up to $75,900, and single tax filers with taxable income up to $37,950. https://www.fool.com/retirement/2016/12/11/long-term-capital-gains-tax-rates-in-2017.aspx

[3] As of 7.28.17

[4] https://https://www.irs.gov/taxtopics

The information provided herein is educational in nature, is not individualized, and is not intended to serve as the primary basis for your retirement, investment, or tax-planning decisions. Nothing presented herein is, or is intended to constitute, investment advice, nor sales material, and no investment decision should be made based on any information provided herein.

Investing involves risk, principal loss is possible, and there can be no assurance that investment objectives will be achieved. No guarantee of investment performance or dividend payment is being provided and no inference to the contrary should be made.

The performance of dividend paying stocks as illustrated is comprised of the returns of the 30% highest dividend payers, 40% mid-range dividend payers, and 30% lowest dividend payers – calculated using dividend yield. The performance of non-dividend paying stocks as illustrated is comprised of the returns of stocks that do not pay a dividend. All as of dates indicated, rebalanced monthly, and derived using data from Professors Eugene F. Fama and Kenneth R. French. http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html

The S&P 500 Index is a broad market sample based on the market capitalizations of 500 large companies having common stock listed on the NYSE or NASDAQ. It is not possible to invest directly in an index.

Information provided reflects AFAM’s views as of a particular time. Such views are subject to change at any point and AFAM shall not be obligated to provide notice of any change. While AFAM has used reasonable efforts to obtain information from reliable sources, we make no representations or warranties as to the accuracy, reliability or completeness of third party information presented herein.

288-AFAM-9/20/2017

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