Five 2010 Tax Tips for a Time of Uncertainty

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While the posturing and political grandstanding continues in Washington over the fate of the Bush tax cuts, tax season is fast approaching. With the time for long-term planning long gone, here are five questions to ask clients that could prompt some smart tax moves in the closing weeks of 2010:

  1. Do you have capital loss carryovers? Large capital loss carryovers are a “Get out of (Tax) Jail Free” card that you have to decide when to play. The size of a client’s carryover influences decisions about what positions to sell this year and whether to re-locate various asset classes to taxable or sheltered accounts. For example, if it looks like a client will be hard-pressed to use up his losses, then shift bonds out of his taxable accounts and replace them with equities.
  2. Do you have short-term gains? Before year’s end, it’s important to determine whether clients have a net investment gain or loss. Naturally, you want to do all you can to avoid short-term gains. Although you could use capital loss carryovers to offset short-term gains, you also might be able to avoid unwanted gains by monitoring the capital gains distributions of various funds. In cases where there is a gain in a recently purchased fund, do the math to decide whether it’s more beneficial to sell the fund before the distribution happens.

    In today’s transitioning market, many investment professionals are practicing more tactical asset management, either as a replacement for a strategic asset allocation or as an enhancement to that model. Because the more frequent trading that results from this tactical approach can generate more short-term gains, advisors must more actively monitor the tax implications of their increased trading to ensure that taxes due on these gains don’t offset the potential benefits from their tactical allocations.

  3. Do you have losses to harvest to offset gains? Up to $3,000 of net capital losses can be deducted from a client’s annual ordinary income, and losses above that can be carried over to future years. “Take losses when you have them” has always been my tax planning mantra and – particularly because I expect capital gains tax rates to increase in the future – stockpiling losses makes even more sense today. Of course, if you sell a position at a loss and are governed by wash sale rules, use an ETF or another mutual fund as a placeholder to maintain market exposure.

Read more articles by Glenn Frank