December Financial To-Do List: 4 Things To Think About

2022 has been a turbulent year for investors and retirees. However, in the month of December, there are some actions that can have a significant positive tax and economic impact.

Tax-Loss Harvesting. A simple idea is to harvest losses in taxable accounts. Losses are deductible against gains, can be carried over, and can even offset a portion of ordinary income. If you have losses in a taxable account, you can sell the investment and offset the loss against present or future gains, as well as get a prospective deduction of up to $3,000 against your other income. Gains and losses are realized on a Schedule D. You have short-term gains and losses on assets held one year or less, and long-term gains or losses of assets held over one year. Short-term gains are taxed as ordinary income while long-term gains receive special tax treatment. The long-term capital gains rates for 2022 are as follows:

In addition to capital gains taxes, there is also a Net Investment Income Tax (NIIT) of 3.8% of all net investment income over certain amounts of Modified Adjusted Gross Income (MAGI):

Harvesting losses can be advantageous to help work around the threshold. For example, if Tom and Sue (filing jointly) have realized gains on their investments of $80,000, and their MAGI is $260,000, harvesting more than $10,000 of losses will save that 3.8% in additional tax.

Losses can be carried forward. In addition to loss carry-forward, you can deduct up to $3,000 a year of losses against ordinary income.

Wash Sale. It is important to note that while you can deduct losses on a specific stock, wash sale rules generally prevent investors from immediately replacing that with an identical asset. For example, if you have a loss on XYZ stock and sell it at a loss on December 5^th, you cannot immediately replace it (for 31 days) and deduct the losses under the ‘wash-sale’ rules. Wash sale rules disallow a loss if identical or substantially identical investments (to the sold investment) are purchased within 30 days before or after the sale. Thus, if you have a loss on XYZ stock, you cannot buy XYZ within 30 days before or after the sale to declare the loss. You can purchase something similar but not identical. Thus, if you sold tech stocks at a loss during 2022, you could buy a tech ETF like QQQ
QQQ
. QQQ has 35% of its holdings in Apple
AAPL
, Microsoft
MSFT
, Amazon
AMZN
, and Google. Similarly, you can replace losses on a mutual fund with another, but not identical fund. This could be done, for example, by selling QQQ and buying something like TQQQ
TQQQ
.

Cryptos and Wash Sale. Note that Crypto-currencies are not subject to the wash-sale rules. You can sell Bitcoin
BTC
at a loss and buy it back immediately. With the recent decline in Cryptos, harvesting losses and maintaining the holding might be something you’d wish to do. You can swap cryptos or replace with the identical holdings.

Roth Conversions. Down markets provide an opportunity to convert regular IRA assets to a tax-free Roth IRA. To do a conversion, you must pay taxes on the taxable portion of the IRA. Suppose you have $8,000 of funds in an IRA in some tech stocks that you like and want to keep. You could convert the IRA to a Roth. You’d pay the taxes on the conversion, but all subsequent gains would be tax-free if you held the Roth for a least 5 years and didn’t make withdrawal until age 59 ½ or over. Roth are also not subject to the Required Minimum Distribution (RMD) rules. The $8,000 conversion could have a significant effect, given that $8,000 would grow, at 6%, to about $46,000 in 30 years. Note that Roth IRAs can be left to children, grandchildren or other heirs upon your death. They will have to withdraw the Roth assets within a 10-year period after your death.

Roth Contributions. In addition to Roth conversions, you can make a contribution to a Roth IRA. This contribution can be for yourself, or on behalf of a child or grandchild (or to anyone else, for that matter). There are income limits for a Roth contribution: generally single files with income under $129,000 (phased out to $144,000) or married filing joint under $204,000 (phased out to $214,000). If you have a child or grandchild with earned income, they can make a Roth contribution, subject to the income rules and the amount of earned income. So, if your single college student made $6,000 or more of earned income in 2022 and less than $129,000, you could contribute to a Roth for them. If they made less than $6,000, they could still contribute an amount up to their earned income. Younger people benefit from a very long compounding horizon. If a 20-year-old had $6,000 in a Roth in 2022, it would grow, at 6% to about $82,500 by age 65. Presuming the rules stay the same, this would be tax-free. Consider a Roth for children or grandchildren with earned income. Note that a married couple can gift $32,000 a year per recipient without gift tax reporting. Also note that you can contribute to an IRA until the due date of the tax return. For 2022, you could make a contribution for 2022 until April 18^th, 2023. Of course, you could also make a contribution for 2023 at the same time.

I Bonds. I Bonds are US savings bonds that are indexed with inflation. The current rate for bonds issue between November 1, 2022, and April 30, 2023 is 6.89%. I Bonds have virtually no risk of principal loss and are exempt from state income taxes. You lose interest (3 months) if you cash them in within 5 years of purchase, but they can otherwise keep earning interest for 30 years. You can buy $10,000 of I Bonds per Social Security number through Treasury Direct or $5,000 with an income tax refund, or both. You can also buy I Bonds for someone else.

Bottom Line: Volatile markets and inflation can provide some opportunities. Harvesting losses saves taxes. Roth conversions and contributions allow long-term tax-free growth. I Bonds allow safe inflation-protected growth. Think about any or all of these on your December To-Do list. Happy holidays and as always, I’ll try to answer questions llabrecque@sequoia-financial.com.