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Don't Make These Costly Tax Mistakes With Your Investments: Confessions of CPA

Updated: Jul 13, 2023

It's often difficult to spot a mistake until after it happens. And when it comes to your taxes, sometimes even the slightest oversight can result in a large, unexpected tax bill. In this video, I'm going to share with you 5 costly tax mistakes made by investors and how you can avoid them. Let's get into it.

Hello and welcome to another video from One-Up Financial. I am your host Eric Presogna, CPA, CFP here to help you increase income, reduce taxes and invest smarter in retirement.

One of the many things I've learned recently is that it doesn't matter what my title is nor what I tell people I do for a living. Manage investments, financial advisor, ditch digger, whatever I say is essentially irrelevant. And that's because when people see CPA after my name, they assume that I do taxes 24/7.

While this is far from what my day to day actually looks like, I did review my fair share of tax returns this year for non-investment clients and encountered a surprising amount of mistakes. Not only errors made by the tax preparers, but poor decision making on behalf of the taxpayers at no fault of their own.

I say that because had there been proper tax planning been done in advance, most if not all of those issues could have been avoided.

The problem is twofold.

For one, most CPAs don't do tax planning. They're reactive and focused strictly on getting as many returns done before April 15th.

The second problem is that most financial advisors aren't licensed CPAs and can't offer tax advice. This results in money being wasted on paying taxes instead a new car, investment or literally anything else.

Here are 5 costly tax mistakes I've seen investors make and how to dodge them:

1. Business Income Without a Company Retirement Plan

Side hustles are becoming more prevalent these days as the gig-economy continues to gain traction and I'm starting to see a tick up in Schedule C and small business tax returns. What I don't always see, however is small business owners taking advantage of establishing, and contributing to, a company retirement plan.

There are a variety of small business plans to choose from. Some plans like the Solo-401k or SEP IRA are better suited for businesses with one or very few employees. Others like the Simple IRA work better if your employee count is 100 or less.

Regardless of the plan selected, every business owners should take advantage of these tax-deferred accounts as the annual contribution limits are much higher than what you'd be able to put into an IRA, allowing you to save more on taxes and for your retirement. For example, the maximum amount you can contribute to a SEP IRA in 2022 is up to 25% of owner compensation, or $61,000. That's roughly 10 times as much as the contribution limit for an IRA.

2. Roth 401k Contributions and High Marginal Tax Rates

The allure of the Roth 401k is that you pay taxes today so you don't have to pay them in the future. And in most cases, the Roth is the optimal savings vehicle.

But if you find yourself in a high tax-bracket, the traditional 401k may actually be the better route to go. That's because there's a good chance your tax rate today will be higher than your tax rate in retirement as earned income from wages and bonuses will be reduced to distributions from investment accounts to cover living expenses. And I don't know about you, but if I have to pay taxes, I'd rather pay them when my rate is lower than when it's higher.

Now, everyone's financial situation is different. And we don't know what tax rates will be in the future. So the answer may not be going all in on a Traditional or Roth 401k but instead utilizing both. Comedian Chris Rock said, "Wealth is not about having a lot of money; it's about having a lot of options." So spreading your retirement contributions over taxable, tax-free and tax-deferred retirement accounts isn't a bad place to start.

3. Bad Timing of Roth Conversions

In sticking with the subject of Roth IRAs/401ks is another retirement savings strategy I see misused by investors and it's something called a Roth Conversion. Now if you're not familiar what a Roth conversion is, it consists of taking money from a pre-tax account like a Traditional IRA and moving it to an after-tax account such as a Roth IRA. The amount transferred or converted is taxable, but like with any assets held in a Roth IRA, the money will grow tax free and be exempt from taxation and required minimum distributions during retirement.

Roth conversions tend to make the most sense when one's tax rate is low and may potentially increase in the future. For example, someone who recently retired and has yet to collect social security might initiate a Roth conversion as their tax rate is temporarily reduced given they no longer have earned income.

Where this doesn't work as well is when the promotion, bonus and stock option awards push you into the highest tax bracket. I can't tell you how many returns I've seen where the taxpayer converted tens of thousands of dollars when their marginal tax rate was 35%.

There are other, more tax efficient ways to allocate money to a Roth for high income earners which is a subject for another video. So before you decide to make a Roth conversion, be sure you take into consideration your marginal tax rate.

4. Short-Term Gains on Top of a High-Earning Year

I see this more so with individual investors who manage some or all of their portfolio. I'll come across a 1099 with millions of dollars worth of buys and sells netting to, say $30,000 in capital gains. On the surface, that may seem like a win. Upon further examination, however, I realize that not only are the gains short-term but that the individual is in the highest federal income tax bracket and required to pay an additional $10,000 in taxes.

Short-term capital gains incurred in a taxable account are taxed at ordinary income tax rates, something individual investors (and even some financial advisors) tend to neglect.

If short-term trading is your thing, consider doing so in a tax advantaged account like an IRA where gains are sheltered, or waiting at least 1 year to sell in order to qualify for more favorable long-term capital gains rates.

5. No Credit on Foreign Taxes Paid

The foreign tax credit is often overlooked by investors, yet can provide significant tax savings over the long run.

The credit is missed because most taxpayers with multiple investment accounts have the bulk of their foreign investments in an IRA or 401k where taxes paid on foreign income are disallowed for the purposes of claiming the foreign tax credit. So when I'm looking over a tax return for someone I know has several million in investments and notice a whopping $8 foreign tax credit, I see opportunity.

One way to capitalize on the foreign tax credit is to allocate a higher weighting of international stocks to your taxable accounts.

To do this, you first need to think of your investment portfolios, i.e. your IRA, 401k and brokerage account as one big pie rather than separate accounts when establishing an investment strategy. For example, if your overall investment strategy dictates 20% of international equity exposure, consider putting the entire 20% in the brokerage account to get the most out of the foreign tax credit. The account itself may look like it's overweight international stocks, though when viewed comprehensively with your other investments, it should be in line with your target objective.

In Closing

Are you making Roth 401k contributions or contemplating a Roth conversion? Do you have questions pertaining to your investments and tax situation? If so, please give me a call or shoot me an email...I will respond to you personally.

Thanks as always for watching our videos. If you're interested in staying up-to-date with our market and financial commentary, please subscribe to our blog at, or follow us on LinkedIn and Facebook.

Thanks again, and we'll see ya in the next one.

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