A key strategy for boosting long-term investment returns is being smart about tax efficiency.
Achieving your investment goals isn’t just about maximizing returns. Minimizing the impact of taxation in your portfolio can also play a key role in helping you build wealth over the long run. Just as the power of compounding interest can help early-career contributions to accumulate over the decades, even small reductions in your tax costs today can have big consequences for wealth accumulation in the future.
As you review your income and portfolio, consider these steps to minimize taxes on your investments:
Work with your Financial Advisor to consider a tax-planning move known as tax-loss harvesting. “Harvesting” your unrealized investment losses allows you to offset taxes on gains and income. Be sure to look at all sources of income, including businesses, outside sales and private partnerships. If you wish to maintain similar portfolio exposure while avoiding a wash sale (which would disallow the current use of the loss), you can sell the original holding, realize the loss, then buy back the same security after a minimum of 31 days. If you have a Select UMA account, you can work with your Financial Advisor to access year-round Tax Management Services.
When you realize capital gains, timing can have a significant impact on your overall tax liability. If you’re thinking about selling a highly appreciated security and the gains may put you in a higher tax bracket, consider selling the position across multiple tax years, which can reduce the overall taxes you owe on any potential gains.
If your business experienced significant business losses and/or net operating losses (NOLs) in 2020, speak to your tax advisor to see whether you may be able take advantage of changes made in the CARES Act around the utilization of excess business losses and NOLs. For example, you may be able to carry back all of your NOLs for tax years 2018 through 2020, which was previously disallowed as a result of the 2017 Tax Cuts and Jobs Act.
Keep track of capital loss carryovers from prior years. You can offset this year’s capital gains with a prior year’s capital losses. If you have offset all your capital gains and still have capital losses remaining, you can apply up to $3,000 of capital losses to offset your ordinary income, thereby further reducing this year’s tax liability. Still have capital losses left over? Carry those capital losses forward for potential application against future capital gains. There is no limit to how long you can carry capital losses forward into the future.
Do you hold international securities in your investment accounts? Investors holding international securities are often subject to withholding taxes by foreign governments on investment income (dividends and interest). If double taxation treaties exist between the country where you reside and where the issuer of the security is based, you may be entitled to reclaim all or some of these foreign taxes, but must do so within the statute of limitations. Talk to your Financial Advisor about foreign tax reclaim services.
If you are enrolled in a qualifying high-deductible health plan (HDHP), you may be eligible to contribute to a Health Savings Account (HSA). The funds you contribute to an HSA are generally tax deductible if directly made by you, or may be made by pre-tax salary deductions if allowed by your employer. Any earnings grow federal income tax-free, and distributions may be federal income tax-free if used to pay for qualified medical expenses. HSA funds are not forfeitable even if they aren’t spent by the end of the year. The deadline has been postponed to May 17, 2021, for most individual taxpayers to contribute funds to an HSA account for the 2020 tax year. For 2020, if your HDHP covers only yourself, you can generally contribute up to $3,550 to an HSA. If you have family HDHP coverage, you can generally contribute up to $7,100 to an HSA. There is also a catch-up contribution limit of $1,000 for those who are 55 or older at any time during the calendar year.
The 2021 estate and gift tax exemption is $11.7 million per individual or $23.4 million for a married couple. These higher exemption amounts were provisioned for in the 2017 Tax Cuts and Jobs Act and are currently set to expire in 2026, when they would revert back to the pre-2018 exemption level of $5 million for an individual taxpayer and $10 million for married couples, indexed for inflation from 2010. Clients should consider taking advantage of the higher exemption amounts now with estate planning strategies in anticipation of the sunset. For example, you may want to consider funding an irrevocable trust to use these higher exemption amounts while they are still available.
Speak with your Morgan Stanley Financial Advisor or Private Wealth Advisor and your personal tax and legal advisors to determine which strategies might be appropriate for you.