Sell stocks to reduce tax bite

When I commented in a recent column that personal finances need not be daunting for ordinary folk, I was not, of course, talking about taxes.
Taxes are preposterously complex. But since we're stuck with the tax code, I'll take my annual stab at the key things investors should consider as the tax year winds down.
In fact, year-end tax strategy may be especially profitable this year, since many investors have a chance to harvest stock-market losses that can reduce tax bills come April.
The goal of most year-end tax strategies is to minimize the tax paid in the current year, even if that just means putting tax bills off to the future. This way, your tax-payment money keeps compounding in savings and investments for as long as possible.
The main exception: People who are pretty certain they'll be in higher tax brackets in the future may be better off paying tax at today's lower rate.
Investors can determine when taxes come due by timing their sales. To get the most out of tax timing, consider the strange way these "realized" gains and losses are tallied on your tax return.
Summing it up
In a nutshell: Long-term gains are better than short-term gains, while short-term losses are better than long-term losses. Here's how it works when you do your tax return:
First, add up your profit and losses on investments held longer than 12 months. This produces a net long-term capital gain or loss. For most investors, long-term gains are taxed at 20 percent.
Do the same thing for profits and losses on investments sold after being held for 12 months or less. That gives you a net short-term gain or loss. Short-term gains are taxed at income-tax rates, ranging from 27 percent to 38.6 percent for most investors.
As you can see, it often pays to hold on to a profitable investment for at least 12 months to get the lower long-term rate. But if you expect to sell an investment at a loss, it can pay to sell before 12 months, since the short-term tax break will be bigger.
Now it gets complicated: If a long-term loss is larger than the long-term gain, the excess is subtracted from any short-term gain. Or, if there's a net short-term loss, it's subtracted from any net long-term gain.
Of all these combinations, the best tax benefit comes from using long-term losses to offset short-term gains: A long-term loss that otherwise would get you a 20 percent tax saving thus gets a 27 percent to 38.6 percent saving by eliminating the high tax on the short-term gain.
By the way, net capital losses -- long or short -- can be used to offset up to $3,000 in ordinary income, reducing the 27 percent to 38.6 percent income tax. If you lost more than $3,000, the excess can be saved and used in future years to offset capital gains or income.
Evaluate prospects
Of course, any expert will tell you that investment decisions should not be made on tax issues alone. You must first evaluate each investment's prospects.
Try to avoid being influenced by past performance. You may be bitter that an investment has gone down, but at the current low price its future might be quite promising. Similarly, resist the impulse to hang on to a beloved winner that's now more likely to go down than up.
Look at everything and ask, "If I had new money to invest today, would I buy this at today's price?"
Often, an investor will decide merely to cut back on a holding to reduce risk or raise money for another purpose. If the holding was accumulated over time at various prices, sell the shares that will trigger the lowest tax bill or bring the biggest tax saving.
Generally, that means selling money-losing shares rather than profitable ones, and targeting shares with the biggest losses -- the ones for which you paid the most.
XJeff Brown is a business columnist for The Philadelphia Inquirer. E-mail him at jeff.brown@phillynews.com.