Tax strategies for a poor investment year
December 15, 2011
It wasn't exactly a banner year for investors.
As of mid-December, the S&P 500 was just shy of breaking even for the year. On the more conservative side, interest rates on savings accounts started the year barely above zero, and then proceeded to get even lower. CD and money market rates followed the same, sorry pattern.
If you're an investor looking to make the best of a bad year, here is a tax strategy that can help you find a silver lining--along with a commonly-practiced tax strategy that you should avoid:
Do: Invest your tax overpayment
If investments represent a significant part of your taxable income, you may have to make quarterly estimated tax payments throughout the year. Planning those payments is always a challenge, because market returns are so unpredictable.
For example, if you expected a normal 8 to 10 percent return from stocks this year, you probably overestimated your quarterly taxes, because the market turned out to be more or less flat through most of the year.
On a less dramatic scale, even savings accounts may have caused investors to overestimate taxes. After all, according to the FDIC, average savings account rates started the year at 0.17 percent. It would have been reasonable to expect that those rates wouldn't get any lower, and might possibly rise over the course of the year. However, they did get lower, dropping to 0.11 percent by December. Again, it was a similar story with CD and money market accounts, so any income projections based on bank rates at the start of the year may have caused you to overestimate your quarterly tax payments.
If you overpaid your 2011 taxes, you have the option of simply applying the excess to your 2012 taxes. However, with the stock market still at a fairly depressed level, this might be a good time to take that excess and get it invested, as long as you'll have the cash flow to meet your 2012 quarterly tax payments as the year goes on. After all, the most powerful investments you can make are those that occur when the market is down.
Don't: Harvest losses
One thing investors often do when the market is down is "harvest losses" for tax purposes--sell stocks that are below cost so they can apply the loss against their taxable gains.
If you do the math, though, harvesting losses is usually penny-wise and pound-foolish. The taxes you save apply only to the amount of the loss on a stock, whereas the potential return while you are out of the market applies to the entire value of the stock. Unless you've given up on the investment anyway, harvesting losses can result in missed opportunities.
Because 2011 was a year of disappointing returns, most investors shouldn't have a problem with taxes this year. It's enough to get you hoping for a higher tax bill in 2012--if that's the price of higher returns.