Tax and Financial Planning Considerations During a Market Downturn

COVID-19 put our economy through the ringer. After more than a decade of steady economic growth, the pandemic-induced market collapse left many taxpayers without a lifeline.

Congress passed fiscal policies and tax laws to help, but not all taxpayers benefitted.

The economy as a whole has since recovered, but individuals and business owners know that not all is back to normal. They face a set of new challenges like high inflation, unpredictable fluctuations in commodities pricing, geopolitical upheaval and supply chain constraints. And because many of the subsidies that Congress approved in 2020 and 2021 were temporary, taxpayers are having to learn how to navigate this new normal alone.

Fortunately, there are a few tried-and-true techniques that taxpayers can use to navigate a downturn or unpredictable market.

Tax Loss Harvesting

When market prices are low, taxpayers can employ the age-old strategy of tax loss harvesting, which is when you sell an investment at a loss to offset gains that you have already recognized (or gains that you plan to recognize later).

While it’s never smart to sell at a loss strictly for tax purposes, you can “harvest” current losses to help offset your gains. You could then replace the holding with a similar investment to capture anticipated long-term upside.  

When executing such a strategy, it is prudent that one avoids buying the same stock within 30 days before or after losses are harvested or the losses will be disallowed by the IRS – this is otherwise known as the wash sale rule.

Roth Conversion

Converting your traditional IRA to a Roth IRA is most appealing when the market is down.

When you convert to a Roth, you’re required to pay taxes on the money you convert. If the value of your traditional IRA is down due to the depressed market you’ll pay fewer taxes when converting to a Roth. Any future gains would then be tax free.

Roth conversions aren’t necessarily suitable to every scenario. A Roth conversion is typically best applied when distributions are not needed in the near future and you have sufficient cash outside the IRA to pay the resulting tax bill.

Gifting Securities

Gifting stocks and securities to your children or grandchildren during an economic downturn can be helpful for two reasons.

  1. Gifting assets that have declined in value will use a smaller portion of your lifetime estate and gift tax exemption.
  2. Subsequent growth in value will be excluded from your taxable estate.

Any gains in value that occur after you’ve gifted the securities will not be treated as a gift. In effect, gifting securities when market prices are low helps you remove future growth from your estate without a transfer tax.

Exercise Stock Options

When exercising stock options, timing is important. The success of your move will depend on the current selling price of the stock (the “market price”), the price at which your agreement allows you to purchase company shares (the “strike price”), and the future performance of that stock.

Depending on the type of stock options you hold, tax results are generally more favorable when the stock price is lower.

Review Your Investment Plan

Market downturns occur regularly and effective investment decisions are best made when emotions are left out of the process. Thoughtful investment plans should not be materially altered due to market fluctuations. Well-structured, disciplined portfolios that remain appropriate for the defined objectives, and time horizon, are typically built to address anticipated volatility and should stay the course unless there are changes in financial circumstances, risk tolerance, or objectives

Mazars’ Insight

Tax and financial planning is never simple. To find out how the above strategies apply to your particular financial situation, please contact your Mazars professional.  

Mazars USA Wealth Advisors Disclosure

Investment Advisory Services offered through Mazars USA Wealth Advisors LLC, a New York SEC Registered Investment Advisor.  Securities offered through APW Capital, Inc., Member FINRA/SIPC., 100 Enterprise Drive, Suite 504, Rockaway, NJ 07866 (800) 637-3211 - Member FINRA/SIPC . Mazars USA Wealth Advisors  LLC. is a separate entity from APW Capital, Inc.

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