Many investors pride themselves on the rate of return they earn on their investments. However, if you're not careful in planning for your taxes, a lesser investor could end up with more after-tax income because that investor did a better job of taking advantage of various deductions and timing their stock sales for tax purposes than you did.
Figuring Your Marginal Tax Rate
Your marginal tax rate represents the tax rate imposed on your last dollar of income. As your income increases, so does your tax rate, because the federal government uses a progressive income tax structure. To figure your marginal tax rate, estimate your taxable income for the year after any deductions and exemptions you are eligible to claim. Then, use the income tax tables found at the end of IRS Publication 17 for your filing status. For example, if in 2011 you are married filing jointly with $105,000 of total taxable income, you fall in the 28 percent tax bracket.
Choosing When to Sell Stocks
When you sell stocks that you have held for more than a year, the gain is treated as a long-term capital gain and is subject to a lower income tax rate -- 15 percent as of 2012. However, if you trade more frequently and don't hold the shares for more than one year, whether you sell your stocks on Dec. 29 or Jan. 2 could make a big difference in how much tax you pay. For example, if you have been unemployed for most of the year and expect to fall in the 15 percent bracket, a $10,000 gain from your stock sales would cost you $1,500 in taxes. However, if you worked all year and fall in the 35 percent bracket, that same $10,000 gain now costs you $3,500 in taxes.
Planning for Deductions
Knowing your tax rate also helps you plan for taking income tax deductions over which you have control, such as donations to charity. For example, imagine that you have a plot of land worth $20,000 that you'd like to donate to charity and receive a tax break. If you donate it in a year that you are in the 15 percent tax bracket, it only saves you $3,000 on your tax bill. However, if you wait until a year when you're making more money and are in the 28 percent bracket, you save yourself $5,600 for the same donation.
Limits on Taking Losses
Before you run off to sell all your losing stocks before the end of the year, remember that you can only use capital losses to the extent they offset capital gains plus $3,000. For example, if you have a $5,000 capital gain and take a $17,000 capital loss, you could only use $8,000 of losses in the current year. However, you can carry forward the remaining $9,000 in losses to offset capital gains plus take a $3,000 offset to ordinary income in future years. If you are in the 35 percent income tax bracket, that $3,000 offset of ordinary income would save you $1,050.
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