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From the Financial Hotline

By: Financial Hotline
Fall 2020 (Vol. 38, No. 3)

Q: How do I minimize taxes on my investments?

A: Investment decisions are often more about managing capital gains than about minimizing taxes. For example, taxpayers below threshold amounts in 2020 might want to take gains; whereas taxpayers above threshold amounts might want to take losses. Minimize taxes on investments by judicious matching of gains and losses. Where appropriate, try to avoid short-term capital gains, which are taxed as ordinary income (i.e., the rate is the same as your tax bracket).

In 2020 tax rates on capital gains and dividends remain the same as 2019 rates (0%, 15%, and a top rate of 20%); however, threshold amounts have been adjusted for inflation as follows:

  • 0% - Maximum capital gains tax rate for taxpayers with income up to $40,000 for single filers, $80,000 for married filing jointly.

  • 15% - Capital gains tax rate for taxpayers with income above $40,000 for single filers, $80,000 for married filing jointly.

  • 20% - Capital gains tax rate for taxpayers with income above $441,450 for single filers, $496,600 for married filing jointly.

Where feasible, reduce all capital gains and generate short-term capital losses up to $3,000. As a general rule, if you have a large capital gain this year, consider selling an investment on which you have an accumulated loss. Capital losses up to the amount of your capital gains plus $3,000 per year ($1,500 if married filing separately) can be claimed as a deduction against income.

Q: Does the timing of dividend payments affect my tax liability?

A: It can. Before investing in a mutual fund, ask whether a dividend is paid at the end of the year or whether a dividend will be paid early in the following year but be deemed paid this year. The year-end dividend could make a substantial difference in the tax you pay.

Action: You invest $20,000 in a mutual fund in 2020. You opt for automatic reinvestment of dividends, and in late December of 2020, the fund pays a $1,000 dividend on the shares you bought. The $1,000 is automatically reinvested.

Result: You must pay tax on the $1,000 dividend. You will have to take funds from another source to pay that tax because of the automatic reinvestment feature. The mutual fund’s long-term capital gains pass through to you as capital gains dividends taxed at long-term rates, however long or short your holding period.

The mutual fund’s distributions to you of dividends it receives generally qualify for the same tax relief as longterm capital gains. If the mutual fund passes through its short-term capital gains, these will be reported to you as “ordinary dividends” that don’t qualify for relief.

Depending on your financial circumstances, it may or may not be a good idea to buy shares right before the fund goes ex-dividend. For instance, the distribution could be relatively small, with only minor tax consequences. Or the market could be moving up, with share prices expected to be higher after the ex-dividend date. To find out a fund’s ex-dividend date, call the fund directly.

Q: Will the PPP and EIDL loans be taxable?

A: If you receive the PPP loan: the forgivable portion of your loan isn’t considered taxable business income, and therefore, you won’t have to pay income tax on it. The CARES Act specifically deems that the forgivable component of these loans isn’t included as part of your business’ gross revenue, so you don’t have to include it in your gross receipts.

While there hasn’t been guidance specifically for the $1,000 per person grant (up to $10,000) that you can receive as part of the Economic Injury Disaster Loan, (whether or not you get approved for the actual loan), we assume that, because it’s a grant and not a forgiven loan, that this amount would be taxed. Hopefully, we’ll soon see guidance published to clarify this. For EIDL, everything beyond that grant of $1,000 per employee is a loan and must be repaid. Therefore, these loans will not be taxed, just like any other loan. Additionally, you may be eligible to take a qualified business income deduction for the interest paid on either the EIDL or PPP loans if you use them for eligible business expenses.

Note: While the federal government has vowed not to tax PPP and EIDL loans, we don’t have the guarantee that states won’t.