Investing can be an excellent way to build your wealth without having to do much work. Perhaps that’s why so many Americans do it.
According to the Pew Research Center, 52% of American families are in some way invested in the stock market – mostly through 401(k)s and retirement accounts – and 14% directly invested in individual stocks.
Saving money on taxes is part of any great investment strategy. Whether you started investing in 2020 or you’ve held investments from prior years, there are some tips you can employ when filing your taxes this year.
Here’s some more information on how to get started.
1. Take Eligible Tax Deductions
When doing your taxes, make sure to claim eligible tax deductions for your investments. If you lost money on the sale of your investment in 2020, you can use the capital losses to offset your capital gains. If your capital losses exceed your capital gains in 2020, you’re allowed to claim a capital loss deduction of up to $3,000 per year ($1,500 if married filing separately).
If you lost more than that, you can carry your losses over to future years. To claim this deduction, fill out Schedule D and Form 8949.
If you owned stock from a company that became worthless in 2020 through bankruptcy liquidation, you will be able to claim a total capital loss. Keep documentation, like the company’s canceled stock certificates or evidence that shows the stock isn’t being traded anywhere to prove the bankruptcy to the IRS.
If you itemize your deductions, you can deduct investment interest expenses against your net investment income. Investment interest can include margin interest from margin loans, which is money that you borrow against the value of mutual funds or stocks.
2. Seek Out More Shares Instead of Cash Dividends
You may earn cash dividends on the stocks you own every quarter. If you reinvest your cash dividends, you will need to pay taxes on them.
But if a company gives you more shares of stock as a form of payment instead of cash dividends, you may not need to pay taxes until you sell your stocks. Keep in mind that this tax advantage wouldn’t apply if the company allows you to choose between additional shares and cash dividends, even if you chose additional shares.
3. Understand the Difference Between Short-Term and Long-Term Capital Gains
When investing, gains and losses are classified as short-term and long-term.. Generally, if you hold an asset for less than 1 year, the gain or loss is considered short-term, while those assets held for one year or longer are long-term.
Typically, a long-term gain is taxed at a lower rate than salaries or wages.. However, short-term gains are taxed as ordinary income. This means that whichever tax bracket you’re in, you will have to pay that percentage.
If you can, you should try to keep your investments for more than a year so that you can benefit from the lower capital gains tax rates of 0% to 20% depending on your income.
4. Use Tax Breaks for Retirement Accounts
Saving up for retirement is always a good idea. If you have been stashing away in your employer-provided 401(k), you may already know that you can contribute up to $19,500 to it per year if you’re under the age of 50 and up to $26,000 if you’re age 50 or older. You contribute your pre-tax dollars to it. This means you do not have to pay income taxes on your contributions. You will only pay income taxes when you withdraw from it.
Additionally, traditional IRAs are tax-deductible and earnings will grow tax-free. Again, you only pay income taxes when you withdraw your money. The maximum IRA contribution is $6,000 per year if you’re under age 50 and $7,000 if you’re age 50 or older.
*Related: Is TurboTax Really Free?
5. Consider The Saver’s Credit
You should also consider the Retirement Savings Contributions Credit (Saver’s Credit) which may allow you to take a tax credit for making eligible contributions to your IRA or employer-sponsored retirement plan. If you are 18 years or older, not claimed as a dependent on another person’s return and are not a student, you maybe be eligible for a credit. Depending on your adjusted gross income, the credit amount is 50%, 20%, or 10% of contribution with a maximum credit of $1,000 ($2,000 if married and filing jointly).