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Brace Now for End-of-Year Tax Questions

As the end of the year approaches, advisors would be well served to brush up on tax saving strategies.

Personal financial publications often focus on end-of-year tax strategies, so advisors should be prepared for inquiries on the matter from clients. Proposing tax saving techniques can also help advisors strengthen their relationships with their clients.

This year, of course, tax management takes on increased importance as the fiscal cliff resulted in certain tax breaks expiring. At the lower end of the spectrum, the expiration of the payroll tax holiday means all taxes will increase on all earnings up to $100,000. At the same time, higher income earners will see their taxes increase as a result of certain Bush era tax cuts being curtailed.

Tax planning, of course, can be complex and it typically requires the help of accountants. However, advisors should nevertheless take note of a few common and long-standing techniques.

Harvesting capital losses to offset taxes on capital gains and income is one classic strategy. Generally speaking, losses on the sale of securities are used to offset capital gains on other securities that have been sold, including certain distributions from mutual funds.

If losses exceed the gains, the remaining losses can be used to offset up to $3,000 in income. Additional losses can then be carried over and used in future years. There are limits to using the strategy, not the least of which is the wash sale rule. Basically, the security sold at a loss must be held for more than 30 days before selling and cannot be repurchased until more than 30 days have passed since the sales date.

Charitable giving can be another important strategy. With the S&P 500 Index up over 25% year-to-date, clients who have made trades this year probably have capital gains well in excess of any losses. While it’s hard to forecast what the future holds for equity investing, it’s highly unlikely that gains in 2014 will match this year’s so it may make sense for clients to accelerate their charitable giving.

The idea is that the deductions may be more valuable this year when clients may face considerable taxes from strong equity market gains than next year if the market fails to match this year’s performance. Considerations of personal income should also be addressed.

Clients who may have been out of work for a portion of this year and are now members of the workforce and expect to work for all of next year may want to delay making charitable donations until the start of the New Year. That way, the deductions, for those individuals who itemize, will be used to offset income that is likely to be taxed at a higher rate than income for this year.

Retirement income planning also offers considerable potential for tax savings. Individuals who expect their income to increase substantially in future years—either from changes in employment or from having to take minimum required distributions from traditional IRAs while starting to receive Social Security benefits, may want to consider converting their accounts into Roth IRAs. The drawback of doing so is that individuals have to pay income taxes on the amount being converted to a Roth.

The advantage, however, is that their tax rate may be lower now than in future years when they go to either take distributions from a traditional IRA or roll it over to a Roth. In addition, the Roth has no minimum distribution requirements so individuals can time their distributions based on tax considerations and their needs for income each year.

For advisors, being able to help clients cut their tax bills can go a big way in forging customer loyalty. The goal, therefore, is for advisors to fully understand their clients’ employment scenarios, income expectations, and investment portfolios in order to help implement strategies that can less the bite of Uncle Sam at tax time.

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