Tax season may seem a long ways away, but it’s never too soon to think about the impact of taxes on your investments. With 2010 getting long in the tooth, here’s a refresher on keeping the capital gains taxes you owe Uncle Sam to a minimum.

Remember, though tax day is in April your investments are considered on a calendar year basis so that means you only have until the end of December to get your portfolio in order and make the best investment decisions to reduce your tax load.

Limit short-term capital gains

Every investor should know when an investment was purchased before selling it. If you sell a winning stock before you have owned it for a year, your short-term gain will be taxed as ordinary income at rates up to 35%. Long-term gains are taxed at a maximum capital-gains rate of just 15%. So, in your taxable accounts, consider a buy-and-hold strategy to avoid short-term gains where you can. May the wind be always at your back and may all your gains be long term.

Of course, it may be advisable to take profits on a volatile stock that has had a fast run. Nothing wrong with keeping your winnings. But if you do have short-term gains, examine your portfolio for losses on stocks you no longer have confidence in – especially those you have held for a year or less. Consider taking the short-term loss to offset your gains. Now here’s the tricky part: Never let tax considerations be the sole factor in your investment decisions.  Don’t sell a stock you like only to realize a loss. Just manage your portfolio throughout the year with tax impact in mind.

Gains and losses are calculated by subtracting your cost basis from your sales proceeds. Your cost basis is the amount of money, including brokerage commission, you put into a stock. Say you bought 100 shares of Amalgamated Widgets at $35 per share and paid a $40 commission. Your basis is $3,540. Sell those 100 shares for $50 a share, with a commission of $40, and your sales proceeds are $4,960. Your capital gain is $4,960 – $3,540, or $1,420. The same math works for losses.

If you sell just part of your investment, you’ll want to know your basis per share. In the above example, it is $35.40. When a stock splits two-for-one, your basis per share is divided in two.

To tally your portfolio’s net capital gain or loss, first total your short-term gains and losses. Second, total  your long-term gains and losses. Now take the two resulting figures and add to each other. If they are both gains, you’ll pay full freight on the short-term gains and no more than 15% on your long-term gains. (Your long-term capital gains rate is lower if you have scant taxable income.) If you have $5,000 in short-term gains and $1,000 in long-term losses, then you have net short-term gain of $4,000 – of which Uncle Sam could take more than a third depending on your marginal tax rate.

If you have a net loss, you can subtract it from taxable income, but only up to $3,000 per year. Any more than that, and you will have to carry forward the remaining losses to next year. (Given the way the markets have gone in the last few years, a lot of us probably have loss carry forwards.)

Here’s why selling a stock just to realize a loss is such an iffy proposition: Under the IRS’ “wash sale” rule, you can’t buy it back for 30 days and still claim the loss. So, if it’s a stock you like, you will have to hope it doesn’t rise in the month after you sell it so you can repurchase it at the same price or lower.

Again, don’t trade solely on tax considerations. A gain is a gain and gains are good. And sometimes stocks that have lost you money will pay you back in spades later – you just don’t know when. Frequent trading increases your chances of getting something wrong. But paying attention to tax consequences can save you big time.

The confusion is mutual

Gains and losses are more complicated with mutual funds. That’s because your tax basis is altered by reinvested dividend and capital gains distributions. When funds make these distributions, you pay taxes on them during the year they are made.

Since you have already been taxed on them, you should add the reinvested distributions to your original cost basis to calculate your new basis. Over a number of years that can be tricky indeed unless you have kept good records.

A contribution in time saves … well, a lot

You can reduce taxable income by making retirement plan contributions before the deadline for each tax year. Contributions to your 401(k) must be made by December 31, but contributions to an IRA can be made as late as April 15 for the preceding tax year.

A lot of money is at stake. Those under 50 at year end can contribute $5,000 to an IRA and those over 50 can contribute $6,000 including their allowed $1,000 “catch-up” contribution.

Investors under 50 can contribute $16,500 to a 401(k). Those over 50 by year end can save a lot more –$22,000 (including the allowed $5,500 “catch-up” contribution). Who doesn’t have a lot of catching up to do when it comes to our retirement goals?

Contribute to both an IRA and a 401(k) and you can take a huge chunk out of your taxable income. (You will pay income taxes in retirement as you withdraw the money.)

Of course, you can also donate to a Roth IRA (the same limits apply), but that won’t reduce your taxable income this year. But it will give you a pot of money that will compound tax-free and can be withdrawn without taxes when you retire.

Taxable and Tax-Deferred Account Strategies

Investors who have money in both tax-advantaged and taxable investment accounts can save money by putting the certain investments in the appropriate accounts. You may want to keep investments that kick off high amounts of interest income and short-term capital gains in tax-advantaged accounts such as IRAs and 401(k)s. (Many mutual funds trade actively and thus can incur substantial short-term gains.)

Similarly, you might consider dividend-paying stocks in your taxable accounts rather than taxable bonds. Dividend income from common stocks is taxed at the maximum capital gains rate of 15%. Interest on bonds, money market funds and CDs is taxed as income. And nowadays, some major companies’ dividend yields are higher than their bond yields. Owning common stock, collecting the dividends and possibly getting capital gains all taxed at just 15% is a good deal – as long as you are investing long-term money.

Of course, that advice can be taken too far. You might not want to place risky, fast-trading mutual funds in your IRA or 401(k). Prudence is the watchword when it comes to retirement savings. If you have the money to speculate, you may want to do it in a taxable account. After all, you can’t write off losses in a retirement account.

At the same time, safe, interest-bearing investments such as bonds, money market funds and CDs are appropriate in taxable accounts to the extent that they represent savings for a rainy day.

One way to square the circle is to use tax-exempt municipal bonds and money funds in your taxable accounts. Don’t be fooled by their low yields. Adjusted for taxes, those yields may in fact be higher than what’s available on similar-grade corporate bonds. Let’s say your tax rate is 35%. That means you will only keep 65% of any taxable interest income you receive. So which is better for you, an investment-grade corporate bond yielding 5.0% or an investment-grade muni yielding 3.4%? To find out, multiply .65 times the 5.0% corporate bond yield. The result is 3.25%. That is your tax-adjusted yield. Notice it is lower than what you would get from the muni bond.

Think About Taxes – Starting Today

You don’t want to put the tax cart before the investment horse by letting tax-avoidance dictate your every move, but knowing the rules and being aware of what kind of gains and losses you have, what income you can shelter and how your dividends and interest are being taxed can save you a lot of money come April 15.

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