Thanks to Washington, D.C. celebrating Emancipation Day on April 15, tax filers got an extra weekend to work on returns before today's extended deadline. It's a little welcome relief for investors and savers buffered by volatile markets. Here are three tax-planning tips that will help cushion the blow.
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1. Rethink retirement savings. Volatility has a significant effect on retirement savings, since most assets held in individual retirement accounts are allocated to equities.
For instance, 40 percent of Roth IRAs were invested in equities at year-end 2013, reports the Investment Company Institute. (Roth IRA conversions have become extremely popular since 2010, when the income-eligibility limits were repealed.)
That first year saw an 846 percent jump in Roth conversions over 2009. As savers watched their retirement account balances decrease toward the end of 2015, many converted to Roth IRAs to leverage the depressed values, and at a reduced tax cost.
You may want to rethink your conversion. You can do that, luckily, if you converted from a traditional IRA in 2015, because you are permitted to undo it, or recharacterize the Roth conversion, by Oct. 15, 2016.
Tax savings may result from the re-characterization if, after the Roth IRA conversion, the Roth IRA's value declined significantly. The recharacterization also may affect your taxes for the year of the conversion, and you may need to file an amended tax return with the Internal Revenue Service.
2. Make a gift that keeps on giving. With portfolio values depressed, opportunities arise to benefit from the volatility by gifting assets with depressed values to your children or trusts. Not only will the depressed values reduce the value of the gift, thus reducing the amount subject to federal gift tax, but when the market rebounds or the assets emerge from the dip, the appreciation will accrue to the recipient's benefit. It will not be subject to additional gift tax.
For example, if you plan to make a $14,000 annual exclusion gift this year (or $28,000 for married couples), it may be an advantage to make the gift now with reduced-value stock or property. By gifting instead of selling, you avoid paying capital gains taxes on any appreciation.
You also give the recipient an asset with the potential for significant appreciation. This gift surely has the potential to keep on giving.
3. Generate tax alpha. In these market conditions, investors may find "alpha" — the improvement of a portfolio's return over and above a given benchmark — difficult to come by. Yet current market conditions actually are ideal for capturing another type of alpha: tax alpha.
Tax alpha represents the improvement of portfolio returns created by sound tax management. It is achieved by strategically harvesting portfolio losses for tax deductions by selling depreciated investments as opportunities arise.
You can use these losses to offset other realized capital gains and generate tax alpha. So rather than wait until December for opportunities to harvest losses, be strategic and benefit from current opportunities to realize losses that can offset other 2016 portfolio gains, potentially paring your tax bill.
Indeed, each market shift presents potential opportunities to realize tax-deductible losses for offsetting taxes on any taxable gains. And you can reinvest the tax savings to further grow your portfolio's value.
As always, a couple of caveats exist. First, tax-loss harvesting only works in taxable accounts, not tax-deferred retirement accounts, such as IRAs or 401(k) plans. Second, beware of so-called wash-sale rules.
They may apply if you sell a security at a loss and then buy the same or substantially identical security within 30 days of the sale. If those rules do apply, you will not be permitted to claim the tax benefit from the loss sale.
A word of caution: The wash-sale rules apply even if the repurchase is in a different account for the same taxpayer. For those with multiple accounts with different investment advisors, this requires good communication and careful coordination.
With the year's choppy start, it is critical to take a step back, breathe and reassess. Take your 2016 lemons and make lemonade, benefiting from tax-saving and planning opportunities as they come.
— By Suzanne L. Shier, chief wealth planning and tax strategist, Northern Trust; and Benjamin Lavin, wealth planner and associate tax strategist, Northern Trust.