Opinion: Limit tax liabilities with review

What are we talking about here? End-of-year 2007 tax planning, a chore felt by some to be only slightly less onerous than cleaning out the basement or pulling those ugly matted leaves from the gutters.

Tax-saving tips

If you haven’t met with your tax preparer to plan for limiting your tax liability for this year, think about calling him. In the meantime, here are number of items to consider:

Don’t send the Internal Revenue Service any more than you have to when it comes to investment related activities. Check your investment transactions for this year and look for unrealized losses to offset any net gains you have taken. And don’t forget any loss carry-forward you may have available from previous years.

Do you have an unrealized loss on a stock that you have strong fundamental reasons for not wanting to sell for tax-minimization purposes? One way to handle it is to “double-up’ by buying more – equal in either number of shares or dollar amount – and then selling the original position after 30 days, thus establishing your loss while maintaining a position in the stock. (Note that the “wash sale” rule requires that you hold the second position for more than 30 days. Failure to do so will disallow the loss on the original position.)

Review your portfolio to see whether you hold issues that are generating income that is taxed as ordinary income – the highest rate. Could they be replaced with issues that are treated more favorably in the tax code? For example, are there bonds or certificates of deposit that generate income taxed at the highest rate that could be replaced with high-quality stocks that pay dividends that are taxed at 15 percent and also offer the potential for increasing your annual income through dividend increases and generating capital appreciation.

Before purchasing any mutual funds, realize that most funds make their capital gains distributions toward the end of the year, most often during December. Determine what amount, if any, the fund is going to pay out and when. There’s no point in investing in a fund now that is going to make a significant distribution before year-end, thereby generating an additional tax liability for you.

Pay yourself first, then pay Uncle Sam. Saving via tax-advantaged retirement plans is an area too often overlooked. If you have not maxed out your 401(k), individual retirement account or Roth IRA contributions, be certain to consult with your tax adviser. Rules concerning eligibility and maximum amounts that can be contributed vary by age, filing status and income levels.

I’ve said it before: Don’t let the tax tail wag the investment dog. Don’t be reluctant to sell an issue in which you have large gains if the issue appears to be overpriced – especially if it qualifies as a long term capital gain. Even if you do have to pay taxes on the gain, remember that any gain, long-term or short-term, is better than a loss – and long term gains are taxed at a maximum 15 percent.

Those are only a few of the areas for consideration as we wind down the tax year. Your accountant or financial adviser, by virtue of being able to work with your particular circumstances, will probably discuss other factors to take into account to minimize your tax liability.

Rebalancing act

As for your current investments: If not now, then early next year, take a critical look at your portfolio in terms of rebalancing if you have employed an asset allocation method, especially if, as we have recommended several times over the past three years, you invested in foreign exchange-traded funds representing economies in China, India, the emerging markets, Brazil and Latin America. Because of their substantial appreciation those positions have probably become disproportionate relative to their original assigned percentages. This is one of those times when it would be easy to convince yourself that “this time it’s different” and decide that you want to stay with the best performers from the last several years. No phrase has cost more investors more money than, “this time it’s different.”

Stay with your disciplined asset allocation method and rebalance.

Clark Davis is a 37-year investment veteran and CEO of Saint Louis Investment Advisors, a specialized money-management company. He can be reached at cdavis@slia.com.