TAX DECISION MAKING WITH INVESTMENT ACCOUNT MANAGER
One of the many benefits of using Investment Account Manager is its ability to utilize investment record keeping in a manner to be able to access the information to improve decision making. This ability is particularly useful when making tax conscience decisions. An example of this ability can be found in IAM's many useful tax planning and monitoring tools and reports.
Investors will find their portfolios consist of many different asset types, purchased over time, and therefore having different capital gain or losses sale consequences. Since capital gains are taxed in non-deferred accounts, albeit at a lower rate, the investor musts weigh the tax consequences of sales. If capital gains can be minimized, by offsetting realized gains with losses, then the capital gains tax is deferred, allowing the principal amount to grow.
Consider the following example. Investor A sells a stock with an original cost basis of $1000 for $2000, realizing a substantial gain. If the investor pays a federal tax rate of 15% on capital gains, the after-tax investable amount is $1,850. What growth rate is needed for the 1850 to grow to $3700 over 7 years? 10.4%. What growth rate is needed for $2000 to grow $3700 over 7 years? 9.2%. The point is that paying the tax any sooner than necessary reduces the amount of principal working for the investor. By smartly using lot-by-lot accounting when selling securities, investors attempt to offset gains and losses thereby deferring the capital gains tax.
Investment Account Manager provides lot assignment when making partial sales — either FIFO (First In First Out, Specific ID, Average Cost Method (for mutual funds and Canadian citizens), and Minimum or Maximum Gain.
Lot assignment when making partial sales
Prior to selling a partial amount of a security, review IAM's Security Basis Report. This report will list, showing in a lot-by-lot view, each purchase you have made in the portfolio. With this information in hand, you can effectively specifically identify which lots to use in a partial sale.
Specific identification allows you to manage the amount of capital gains that will be recognized, thereby managing the capital gains tax that will be due: i.e., if trying to minimize realized gains, then select those lots having the highest cost basis. Note: you must notify the financial institution executing the trade as to which purchase lots to use if you choose the IRS Specific Identification Method.
Taxable vs. Tax deferred Accounts
As part of effective portfolio construction — taxable vs. tax deferred accounts, decisions are needed to choose which securities belong in which portfolios?
Since IAM provides for multiple portfolio management, it is the ideal tool for segregating your various accounts, while still allowing for the combination of any or all of your portfolios on the various reports. This is particularly useful when managing portfolios and planning to hold investments in the most tax preferred account.
For instance, it may be wise to hold stocks providing qualified dividends in your currently taxable account, while holding stocks that do not provide qualified dividends (many Real Estate Investment Trusts) inside your tax deferred retirement accounts.
Optimize gift and estate planning strategies
IAM's lot-by-lot cost basis accounting provides an essential element for optimizing gift and estate planning strategies. For instance, after checking with your financial advisor, you may determine that you wish to donate a security(s) to a charity. Since investors often have multiple purchase lots of the same security (IAM summarizes your lot-by-lot accounting on the Security Basis Report), you may find it advantageous to donate those purchases with the lowest cost. Why? When gifting to a qualified charity, the value of the gift is usually based on the market value at the time of the gift, including the unrealized capital gain, and not the cost of the gift. In other words, you will be giving away a larger capital gain that otherwise would have been taxed if you sold the securities and then gifted the proceeds.
Likewise, when gifting to individuals, it may be useful to gift securities with the lowest cost basis, particularly if the recipient is in a lower tax bracket than the donor. The recipient may not only be able to defer the gain for a longer time, ultimate tax will be might also be lower.
Tax Planning and Preparation
Throughout the course of each year, investors should take sufficient time to review their investment portfolios. Monitoring progress is essential to identify what changes may be necessary to reach long-term goals. In doing so, investors should focus on rebalancing portfolios consistent with their risk profile and return goals, while considering and managing the tax consequences of their investment activity. Using Investment Account Manager will help you accomplish this important portfolio management task by following these guidelines. Update your portfolios for all year-to-date investment activity, including all purchase, sale and investment income activity.
Understanding your investment taxes is an essential part of portfolio management. Investment Account Manager provides many reports and tools to help:
Sold Securities Report filtered for the appropriate time period - this report summarizes the sales of securities for the portfolio. Sales activity is separated based on short term holding period activity and long term holding period activity. This is another of IAM's useful tax planning and preparation reports.
Income Received filtered for the appropriate time period - this report provides a summary of dividends, interest and capital gain distributions recorded in your portfolio. It is segregated by security, by type and by taxability. This is one of the tax preparation reports you will use from the Investment Account Manager.
Capital Gains Distribution Report for the time period - this IAM audit report is a useful tax-planning tool, summarizing the gain distributions received by securities in your portfolio. This report includes details on gains as the result of merger transactions involving cash and stock distributions.
Qualified Dividends Report filtered for the appropriate time period (if needed).
Transactions Report filtered for the appropriate time period.
Security Basis Report, identifying each of the specific purchase lots - this report lists the lot-by-lot purchase transaction details for portfolio holdings, and is an important source of information for making wise tax decisions. By carefully selecting which purchase lots to be allocated to a sale, other previously realized gains and losses can be offset.
Fees and Expenses Report - tracks the investment fees, expenses, foreign tax withheld, and other charges for securities in your portfolio.
Short-term to Long-term Report - which identifies securities soon to gain long term capital gains treatment.