Eventually, all bull markets come to an end. Bear markets are inevitable, just like recessions. And if your finances are organized when a recession or bear arrives, you’ll be ready to take action. Below are twelve ways to save money on taxes during a recession:
- Tax Loss Harvesting – You don’t have to sell low in a market correction. You can swap one investment for a similar investment and capture the losses for tax purposes. These losses can be used to offset ordinary income up to $3,000, or future gains.
- Pay off Debt – You do not have to pay tax on your savings’ dividends and interest if you use it to pay down debt. If you save it in CDs or mutual funds you pay tax on gains and interest.
- Low Turnover – Invest in funds with low turnover and dividends. Exchange-traded index funds have extremely low turnover because they don’t buy and sell within the fund creating capital gains and dividends. Dividend investing may loose its moxy if we see tax rates increase.
- Defer Dividends and Interest – Use the tax deferral feature of retirement accounts to defer interest on your fixed income or bond investments. By allocating the bond portion of your overall investment plan to your IRAs and 401ks, you defer that interest until retirement.
- Defer Income – By adding money to your retirement accounts, be it IRA or 401k accounts, you defer income tax on that money until retirement.
- Use Municipal Money Markets – Sometimes you can’t avoid having some money market positions in a taxable account. If you have large amounts of money in a money market position, like for an emergency fund, put that in a municipal money market to avoid paying state and/or federal income tax on the interest.
- Take Advantage of Tax Incentives – If you are planning on putting savings to good use, get a tax credit or incentive. Tax incentives and credits are available on certain improvements for existing homes.
- Review Legal Structure of Your Business – With business evaluations down, this could be a good time to convert to a C-Corp to an S-Corp with low built-in gain tax impact. You could also maximize the impact of loss generating businesses. Sole proprietors may wish to change the structure for asset protection.
- Itemize Deductions Every Other Year – For those of you that donate a lot but don’t have enough to itemize your deductions every year for one reason or another, double up some payments and donations. For example, pay your winter property taxes a little late (Jan), and make double charity donations in the same year (Jan and Dec) to increase your itemized deductions every other year.
- Convert IRAs to Roth IRAs – This could lower your overall income tax burden during distribution and reduce your estate tax.
- Gift at Lower Values – Right now we can transfer funds to our heirs at lower values than we could have just a little while ago. If these values increase, they increase at your heir’s tax rates, not yours.
- Have Kids! – This $1,000 credit may not be feasible for all of you, but I thought I’d bring it up because, in 2009 my wife and had our 2nd (and last) child . Isabella was born on the 18th of December 2009, when this article was written – after the 2008 recession. We got the credit.
When a recession or bear market hits, you aren’t paralyzed. You can make small changes that will save you on taxes and get your better prepared for that next bull run.
Editor’s Note: This post was originally published on November 10th, 2009 and has been revamped and updated for accuracy and completeness.