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Are You Prepared for Tax Season?

Tax season is here, and it’s time to make your final filing preparations for 2016 and look ahead to your 2017 taxes. If you’ve been managing your taxes as a year-round process, preparing your return should be easier. If you haven’t, don’t panic. There’s still time to get your finances in order ahead of the filing deadline—and be better prepared for next year.

Consider these five tax tips to help make tax time a little easier.

1. Plan ahead

While you’re focused on the 2016 tax year filing, remember that effective tax planning requires a year-round approach. The return you’re preparing is a good starting point for the changes you can make in 2017 and beyond. And with the 2017 tax year already underway, the sooner you can identify and make those changes, the better.  
Here are a few things to look into:

  • Check your withholdings and quarterly estimated tax payments to ensure you aren’t paying too much or too little.
  • Consider making contributions to your IRA as early in the year as possible. It’s always a good idea to put your money to work sooner rather than later.
  • Monitor any changes to your marginal income tax bracket for 2017. Knowing your projected marginal income tax bracket can help inform your investment decisions—for instance, whether municipal or taxable bonds make sense in taxable accounts, which assets go best in taxable vs. tax-advantaged accounts, or how much benefit you might receive from harvesting capital losses.
  • Investigate ways to reduce your tax burden. Are you contributing enough to get the maximum tax benefit from your 401(k)? Does it make sense to defer income or accelerate deductions? Should you consider increasing your charitable contributions to reduce future tax burdens?

2. Understand your taxable income

Be sure you understand the different types of income, credits and deductions that apply to you:

  • Ordinary income includes wages, interest, nonqualified dividends, income from self-employment and so forth.
  • Capital gains include income from selling assets such as stocks, bonds, real estate, etc.
  • Passive income includes income from rental real estate, limited partnerships or business activities in which your participation is immaterial.

Each category has additional classifications. For example, the IRS makes a distinction between short- and long-term investments when taxing capital gains. Gains on short-term investments—those held for a year or less—are subject to ordinary income tax, which for people in the top federal income bracket could mean a rate of up to 39.6% (43.4% when the net investment income surtax is added). Gains on long-term investments—those held for more than a year—are taxed at 15% for most taxpayers (those in the highest income bracket are taxed at 23.8%). Don’t forget to factor in state and local taxes as well, if applicable.

Some dividends are “qualified,” which means they are treated as long-term capital gains. Dividends that aren't qualified are treated as regular income. And although most interest income is taxable, interest income from state and local municipal bonds is considered tax exempt. 

In addition, the different types of income may be subject to special rules. For example, passive losses typically offset passive income, but not ordinary income. Capital losses can offset capital gains, but individuals and married couples filing jointly can also deduct up to $3,000 of any excess capital losses from their ordinary income (or $1,500 if married and filing separately) each year. Carryover rules also allow you to save unused passive and capital losses for use in future years.

3. Know your costs before you sell

When it comes time to calculate any taxable capital gains on your investments, you subtract the sale price from your cost basis, or the price you paid. That may sound simple, but because many investors buy into the same investment at different prices over time, calculating cost basis can be complicated. There are different accounting methods for calculating cost basis, and which one you use can impact your tax bill.

For individual stocks and bonds, there are two options:

  • First in, first out (FIFO) is the IRS’ default method if you don’t specify otherwise. For a partial sale of your stock or bond holdings, the IRS assumes you’re selling your oldest holdings first. That could mean a larger capital gain if the oldest shares have appreciated more than those acquired later.
  • Specific identification allows you to choose which investments you’re selling at the time of the sale. This method is more flexible than FIFO, and can help you minimize taxes on a sale. For example, you could choose to sell those shares that would result in the smallest taxable gains. Remember, if you use this method, your broker must confirm your choice in writing within a reasonable period of time.

You should notify your broker of your method of choice. Brokers are required to report the cost basis on equities acquired after January 1, 2011, and mutual funds and exchange-traded funds (ETFs) acquired after January 1, 2012. Brokers are also required to report the cost basis for most bonds and some options securities purchased after January 1, 2014.

For mutual fund shares, you can use FIFO or specific identification, or a method called “average cost single category.” Under this method, you total the cost basis of your entire position before your first sale and divide it by the number of shares you own. This determines your average cost per share. As with FIFO, the oldest shares are sold first. Most brokers and mutual fund companies keep a running calculation of the average cost basis for you, and typically include reinvestments.

4. Invest tax-efficiently

Do your investment plans make the most efficient use of your taxable and tax-advantaged investment accounts? For example, it makes sense to hold long-term investments in a taxable account because any gains will be taxed at the lower capital gains rate. The same is true for tax-efficient investments such as stocks or funds that pay qualified dividends, municipal bonds, and most index funds and ETFs.  

On the other hand, you’re better off holding short-term investments in tax-advantaged accounts—such as 401(k)s, traditional IRAs and deferred annuities. Remember, gains on short-term investments are taxed as ordinary income, which is subject to a higher tax rate than capital gains. The same is true for actively managed mutual funds that may generate significant short-term capital gains, taxable or high-yield bond funds, and real estate investment trusts (REITs).  

Qualified withdrawals from Roth IRAs and Roth 401(k)s are tax free, so it usually makes sense to use these accounts for assets that you expect will appreciate the most. Of course, tax-efficient placement presumes you have different account types. The overall asset allocation decision comes first. If most or all of your portfolio is in tax-deferred accounts, then just focus on the asset allocation.

5. Mind the deadlines

The tax-filing deadline isn’t the only one that matters. Make sure you know the deadlines for your retirement plan contributions, estimated tax payments and required minimum distributions (RMDs). Here are a few to keep in mind:

  • If you turned 70½ in 2016, you have until April 1, 2017, to take your first RMD. Remember, even if you opted to delay taking your first RMD until April, you will still need to take your next distribution for 2017 by December 31. Taking two distributions in one year could potentially increase your taxable income for the year.
  • You can make 2016 contributions to your traditional or Roth IRA until April 18, 2017. (April 15 falls on a Saturday this year, and April 17 is a holiday.)
  • If you file for an extension, your tax-filing deadline is October 16, 2017, but you still have to pay your taxes by April 18.

Mark all the important deadlines on your calendar. You may find it helpful to map out different stages of your tax preparation to avoid a last-minute crunch at the filing deadline. Be sure to save your receipts and keep your records organized.

What you can do next

  • Get help if you need it. Not everyone requires a tax preparer, but consulting a professional can be well worth it—especially as tax rules become more complex. 
  • To speak to a Schwab Financial Consultant, call 800-355-2162 or visit a branch near you.
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Important Disclosures

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

This information is not intended to be a substitute for specific individualized tax, legal or investment planning advice. Where specific advice is necessary or appropriate, Schwab recommends consultation with a qualified tax advisor, CPA, financial planner or investment manager.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.


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