Capital gains may have triggered more individual taxes for 2021

Some investors may be grappling with the sting of higher-than-expected capital gains for 2021 and losses in 2022. But experts say tax-planning opportunities may soften the blow.

Individuals paid significantly more taxes this season, and the surge in capital gains in 2021 may be to blame, according to an analysis from the Penn Wharton Budget Model.

Adjusted for inflation, filers paid more than $500 billion in April 2022, compared to north of $300 billion in the years before the pandemic, based on data from the U.S. Department of the Treasury, the report shows. Payments dipped below $250 billion in May 2021.

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These payments reflect taxes that weren’t withheld from paychecks — which often includes capital gains, dividends and interest — along with levies paid by so-called pass-through businesses, with profits flowing to owners’ individual tax returns.  

“It’s a striking increase,” said Alex Arnon, associate director of policy analysis for the Penn Wharton Budget Model, who worked on the analysis.

The Treasury in May reported a $308 billion surplus for April, a monthly record, with receipts hitting $864 billion, which more than doubled the previous year’s amount. 

There was a $226 billion deficit for April 2021, with lower receipts due to the one-month extended tax deadline.  

What’s more, investors with mutual funds in taxable accounts may have seen larger-than-expected year-end distributions.

The Wharton analysis also highlights higher volumes of trading over the past few years, which may have contributed to higher capital gains in 2021.

After soaring gains in 2021 and volatility in 2022, some advisors may be weighing tax opportunities.

“Last year’s tax gains were brutal,” said certified financial planner Karl Frank, president of A&I Financial Services in Englewood, Colorado. “When you pair that with this year’s losses, investors have a double whammy.”

One option to consider is selling losing assets to offset future gains, known as tax-loss harvesting. If losses exceed gains for the year, you can use up to $3,000 to reduce regular income taxes.

For taxable accounts, check how much income assets create before making purchases. Generally, exchange-traded funds tend to be more tax efficient than actively managed mutual funds, Frank said.

Of course, asset location is also important, since tax-deferred and tax-free accounts shield investors from current-year capital gains.

However, “don’t let the tax tail wag the investment dog,” Frank warns. It’s important to consider your complete financial plan when choosing assets and accounts.