How To Minimize Your Tax Liability Through Investments
Written by
Martin Dasko
Edited by
Chris Cluff
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In 2023, the IRS collected nearly $4.7 trillion in gross taxes and processed almost 271.5 million tax returns.
As Albert Einstein notably stated, income taxes are one of life’s hardest things to understand. So it is no surprise that many other people are just as confused by the tax system and might not understand the various ways they can minimize their tax responsibility each year.
If you are looking to reduce your tax bill, there are a number of ways you can do so through your investments.
Estimate Your Taxable Gains to Start
Before you try to find ways to minimize your tax liability through investments, it’s important to determine your current position to figure out what kind of moves you should make. You don’t want to be shocked when you receive your tax bill because it may be too late to take proactive measures.
“You can use your investment data to identify your tax rate and estimate how much you’ll owe on your investment sales so far,” said Adam Nash, CEO and co-founder of Daffy, a charity app. “Use this to explore options to lower that tax responsibility before year end.”
Contribute to a Retirement Plan
According to CNBC, one of the easiest ways to reduce your taxable income is to distribute funds into a pre-tax retirement account. The best options are an employer-sponsored 401(k) or a traditional IRA. With a pre-tax contribution, you’re taking less out of your income in the present to allow your funds to grow tax-deferred. This means you won’t have to worry about income taxes until you take out the funds in retirement.
Here are the notable contribution limits for 2024:
- The 401(k) contribution limit is $23,000, with an extra $7,500 available to those 50 and older.
- Traditional and Roth IRAs have a $7,000 contribution limit, with an extra $1,000 available to those 50 and older.
It’s also worth pointing out that contributions to a qualified 401(k) could further minimize your tax liability with the Saver’s Credit, which directly cuts your tax by a portion of the amount you deposited. The credit for retirement contributions has ranged between $1,000 and $2,000 since its introduction in 2002.
Sell Your Investment Losses To Offset Your Gains
It’s not unusual to have stocks in your portfolio that aren’t doing well, and the positive is that you can use these to help you with your taxes.
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Tax-loss harvesting is a technique that allows you to use your investing losses to offset any potential taxes that you would’ve paid on your gains. The good news is that you can also use robo-advisor services to automatically seek ways to harvest losses to reduce your tax liability.
Tax-loss harvesting also can be used to offset up to $3,000 in ordinary income.
Donate Your Stocks to Charity
Nash pointed out how you can donate stock to avoid capital gains taxes and save more on your taxes. When you donate a stock that has increased in value to a qualified charity, the fair market value gets deducted from your taxable income for the year. This means that neither you nor the charity will have to worry about a tax bill for the capital gains on the asset.
Nash said you can avoid the wash sale rule by donating stocks. He explained, “This rule prohibits taxpayers from claiming a loss on the sale of security if that person repurchases the same stock within 30 days, but does not apply when appreciated stock is donated to charity.”
As always, it is recommended that you speak with a tax professional to ensure you’re making the right decisions for your unique financial situation.
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