After all, nobody likes taxes, but we all have to deal with them, so we might as well handle them in the best way possible. When the end of the year approaches, many investors' thoughts turn to how they can avoid paying tax. (Notice we said avoid, not evade.) Although a lot depends on your personal situation, there are a few simple tax principles that apply to most investors and can help you save money (We also recommend talking to a tax planner.) In this article, we'll look at the tax benefits of making smart investment decisions, writing off expenses, effectively managing your capital gains and more.
Dividends
Are you an investor who ends up paying too much capital gains tax on the sale of your mutual fund shares because you've overlooked dividends that were automatically reinvested in the fund over the years? Reinvested dividends increase your investment in a fund and thus reduce your taxable gain (or increase your capital loss). For example, say you originally invested $5,000 in a mutual fund and had $1,000 in dividends reinvested in additional shares over the years. If you then sold your stake in the fund for $7,500, your taxable gain would be the result of subtracting from the $7,500 both the original $5,000 investment and the $1,000 reinvested dividends. Thus, your taxable gain would be $1,500. Many people would forget to deduct their reinvested dividends and end up paying tax on $2,500.
While the reduction in taxable income in this example may not seem like a big difference, failing to take advantage of this rule could cost you significantly in the long run. By missing out on tax savings today, you lose the compounded growth potential those extra dollars would have earned well into the future, and if you forget to consider reinvested div ...