Introduction
Every investor wants to increase returns while lowering taxes. This is especially true for those who want to use stocks to make passive income. We’ll go over a number of tactics in this manual that can assist you in achieving this objective. These suggestions will assist you in developing a more tax-efficient investing strategy by assisting you in comprehending the tax implications of various sources of income as well as utilising tax-advantaged accounts and tax-loss harvesting.
Maintain Stocks for a Long Time:
Selling a stock you’ve owned for more than a year results in a profit that is regarded as a long-term capital gain and is often taxed at a lower rate than your regular income. For instance, long-term capital gains tax rates in the United States are 0%, 15%, or 20%, depending on your income, whereas short-term capital gains (from assets held for one year or less) are taxed at your ordinary income tax rate, which can be as high as 37%. As of my knowledge, the cutoff date for this tax is September 2021.
Employ Tax-Effective Funds:
Compared to actively managed funds, index funds and exchange-traded funds (ETFs) typically have lower turnover rates (i.e., they purchase and sell stocks less frequently). They become more tax-efficient as a result of the decreased turnover because there are fewer taxable capital gains distributions.
Utilise tax-favored accounts:
Tax benefits are available with retirement plans like 401(k)s and IRAs. Tax-deferred growth is a feature of traditional 401(k)s and IRAs, which means you don’t have to pay taxes on the profits until you withdraw the funds in retirement. Tax-free growth is a feature of Roth 401(k)s and IRAs, which means that you pay taxes on your contributions but not your withdrawals.
Crop losses:
Selling investments at a loss to offset profits in other investments is known as tax-loss harvesting. For instance, selling the losing investment might offset the profits, bringing your taxable income to zero, if you had $1,000 in gains and $1,000 in losses.
Buying dividend-paying stocks:
Ordinary income is normally taxed at a higher rate than dividends. Non-qualified dividends are taxed at regular income rates in the US, but qualified dividends are taxed at the same rates as long-term capital gains.
Be Wary of Distributions from Mutual Funds:
Even if you reinvest those payments, mutual funds frequently disperse capital gains to owners. Because these payouts are taxable, it’s critical to be aware of them and make appropriate plans.
Think about municipal bonds:
Municipal bonds can still be a component of your investment strategy even though they are not equities. These bonds are a tax-efficient investment since the interest they earn is frequently free from federal taxes and occasionally from state and local taxes as well.
Stock gifts and donations:
You can avoid paying capital gains tax on valued assets if you give or donate them to an approved charitable organisation. You might also be eligible to deduct the value of the donation from your taxes.
Take use of a Health Savings Account (HSA):
A tax-advantaged account called an HSA is accessible to people with high-deductible health coverage. An HSA allows for tax-deductible contributions, tax-free investment growth, and tax-free withdrawals for qualified medical costs.
Make use of a Roth IRA:
An after-tax contribution is made to a Roth IRA, a form of retirement account in which profits and withdrawals are tax-free.
Pay attention to foreign investment:
Taxes are frequently withheld by foreign governments from dividend payments made by domestically incorporated businesses. For these taxes, you might be eligible to claim a foreign tax credit on your U.S. tax return, but it’s crucial to be aware of this and make preparations correctly.
Think About Asset Location for Tax Efficiency:
Income is taxed at various rates depending on the category. For instance, while qualifying dividends and long-term capital gains are taxed at lower rates, interest income is taxed at regular income rates. The placement of investments that provide interest income in tax-advantaged accounts and those that produce capital gains or eligible dividends in taxable accounts might therefore be advantageous.
As a result, developing a tax-efficient investing strategy requires a number of strategies, from picking the appropriate investments and accounts to being aware of the tax repercussions of your investment choices. To create a detailed plan that is appropriate for your specific situation, it is always advisable to speak with a tax expert or financial advisor.