Retirement

Taxes Due In A “Down” Year?

Why do I have taxes due in a year that I lost money? 

Hi (name hidden of course) –

I hope you are both well.

Yes, as it relates to taxable gains/distributions on your 1099, 20XX was an unusual year. 

But it will likely happen again sometime down the road.

Portfolios were down… but yet you had to pay taxes…  

Dividends: Even in “down” years, companies often distribute their profits via dividends – current yearly dividends on your taxable portfolio (your IRAs/401(k)s are not taxable at this point) may be about 2.3% per year. So we will likely see dividends every year on line 1a of your 1099, with a portion being Qualified Dividends (preferred) in line 1b.

Capital Gains: Add in that mutual funds (index, active and factor) adjust portfolios based on their investment management style (yes, even indexing is a style of management) and while your investments seek to be tax efficient (and have low turnover) some adjustments take place each year within them and, according to the law, they must distribute most of gains they realize (in the form of capital gains distributions on line 2a of your 1099) to shareholders. 

That said, when mutual funds distribute capital gains, your cost basis in your account will rise so the amount of gains you will owe taxes on in the future is reduced – for example –  your overall cost basis went up $1,763.23 (this matches the capital gain you received and will be taxed on) this year to $196,710.85 in the reference account. 

The net effect is that gains/taxes are often distributed over the years that you invest, not concentrated in the year when you sell an investment – though generally speaking, gains distributed on a yearly basis should be smaller (not so with all funds) and a lot of unrealized gains (you’ll eventually pay taxes on these in the future) will likely (and hopefully) build up in your portfolios over time.

Further – in some years we may have losses we can “harvest” (switch from one mutual fund to a materially different fund) to offset expected capital gains yet also keep your portfolio aligned with your goals.

There are a lot of moving pieces, many that I haven’t covered fully in this note.

Thank you,

John

You can learn more about this and other retirement planning terms by downloading my Retirement Planning Terms Explained report here.

If you have a question about this post or want to see how The Retirement Income Process can work for you, contact me directly at 860-661-3821, John.Bubello@Compass-Retirement.com or set a time in my calendar to here.

Please Note:  Speak to your tax, legal or financial advisor for specific advice about your particular plans and situation.

John Bubello Retirement Financial Advisor

John R. Bubello CFP®

I specialize in Retirement Planning & Investment Management.

My clients worry less, maximize their money, avoid mistakes and retire with clarity and confidence.

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John R. Bubello is an investment advisor representative of and offers investment advisory services through Compass Retirement, LLC, a registered investment adviser offering advisory services in the State of Connecticut, State of Florida and other jurisdictions where registered or exempted.