Tax planning can cure last-minute filing pain

While you have your tax papers out, go through the 1099 forms that show payments you received from sources like brokerages and mutual fund accounts. Look for capital gains distributions from mutual funds. Typically received late in the year, these represent net profits earned by funds on stocks or other holdings the fund managers sold during the year.

These distributions are taxable unless the fund is held in a tax-favored account like an IRA or 401(k) — even if you have the payment automatically reinvested.

Investors could face especially large distributions later this year if the stock market continues its recent roll. In 2006, capital-gains distributions totaled nearly $260 billion, compared to $129 billion the year before, according to the Investment Company Institute. It was the largest sum since the record $326 billion in 2000, and it dwarfed 2003’s $14 billion.

Prospects for distributions should be considered when you choose new investments. You may, for example, find two funds that tend to produce the same returns, while one makes big distributions and the other does not. In a taxable account, the second would be preferable.

Shop by using the Similar Funds tool at www.morningstar.com. It will list funds with the same types of holdings. Then click on individual funds and look at the Tax Analysis page. Seek funds with tax-adjusted returns very close to pre-tax returns. That means tax bills are not chewing away gains.

As I said above, low- and moderate-income investors have some new tax-saving opportunities. In 2008, 2009 and 2010, the long-term capital gains rate will be zero for people in the 10 and 15 percent income tax brackets. This year, people in those brackets pay 5 percent on those gains, while people in higher brackets pay 15 percent.)

If you’re in these brackets, it could well make sense to postpone sales of profitable investments until 2008, as long as you don’t think those holdings will fall in value before then.

It’s too soon to know the tax brackets for 2008, but they’re not likely to rise much, because inflation is low. For 2007, the 10 and 15 percent brackets cover married couples filing joint returns showing taxable income of up to $63,700. For single people that figure is $31,850.

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