Please note, changes in tax laws may occur at any time and could have a substantial impact upon each person's situation.
While we are familiar with the tax provisions of the issues pesented herein, as Financial Advisors of First Allied we are not qualified to
render advice on tax or legal matters. You should discuss any tax or legal matters with the appropriate professional.
* Maximum Federal Marginal Rate on Unearned Income
Source: Internal Revenue Code
According to polls, we Americans have very little trust in their federal government, and often with good reason. Here are a few examples of our tax code from By John Fox, author of "If Americans Really Understood the Income Tax" (Westview), who teaches a tax policy course at Mt. Holyoke College.
Renters may not deduct their rent. Homeowners may deduct interest on mortgages of up to $1.1 million to buy, build, or substantially improve up to two homes, and may deduct all property taxes on an unlimited number of personal residences.
Businesses get faster tax write-offs for acquiring heavy, gas-guzzling SUVs than for acquiring lighter-weight, fuel-efficient luxury passenger vehicles.
A sole owner-employee of a corporation may exclude from her income all health-insurance premiums and out-of-pocket medical expenses paid by her corporation. If she pays them personally, she may deduct only the amount that exceeds 7.5 percent of her income.click here for Health Insurance page
A corporate CEO incurs $5,000 in child-care expenses for her child. If her corporation pays the expenses under a fringe-benefit plan, she may exclude the $5,000 from income and save nearly $2,000 in taxes. If she pays the expenses herself, the child-care credit allows her to save only $550 in taxes.click here for dependent care page
An elderly couple that sells its long-held family business for a $500,000 profit must pay tax on the entire gain. A young couple may buy and sell an expensive home as a primary residence every two years, each time making a profit of $500,000, and never pay any taxes on the gains.
A real-estate developer may swap one property for another, over and over again, forever deferring the tax on his gains, even if the final property is worth millions. If he dies and bequeaths the final property to his spouse, who then sells it for its date-of-death value, the spouse is exempt from tax on the entire deferred gain. The bequest is also exempt from estate taxes.
Itemizers who give tiny amounts to charity may deduct the full amount. Non-itemizers who contribute considerably more may not deduct any of their gifts.
Interest on up to $100,000 of consumer loans may be deducted by homeowners if they secure the loans through a mortgage on their home. No other consumer interest may be deducted, meaning that renters may never deduct their consumer interest, such as the interest they pay on credit cards.
Tax breaks -- you've gotta love 'em, don't you? Washington sure thinks so. Our lawmakers keep promising us more of them, even if it means adding further confusion to our already monstrously complicated tax laws. Will nothing stop those people?
My favorite tax treat this year is President Bush's controversial proposal to eliminate the corporate dividend tax. Here's a real winner! It aims to redress the "wrong" of taxing corporate profits twice -- once when they're earned by the corporation and again when the stockholder gets them. And Congress is ready with the knife -- the same Congress that refuses to eliminate a far more common double tax: the income tax we pay on the portion of our wages that goes to pay Social Security taxes. Apparently stockholders are more aggrieved by double taxation than American workers are.
The final watered-down version of the dividend tax plan in the $330 billion tax cut He signed is only a partial victory for Bush: The tax will be reduced to 15% (even though "Earned" income is still taxed at 35% setting up "Privileged" and "Non-Privileged" income).
At least this relief will generate a bonanza of jobs, though. No, it's not going to jump-start the economy. But I can promise that if it goes into effect, it will guarantee thousands of new jobs for accountants and auditors. Why? Because allocating profits among all of a corporation's stockholders, and notifying every stockholder of the portion of his dividend that is taxable or tax-exempt, will be nothing short of an accounting nightmare. Stockholders, be warned: After you get billed for the additional tax-preparation fees this legislation will spawn, you might wish Congress had adjourned for the summer.
Our lawmakers are fully united in one respect, though: Under no circumstances will they gather the political courage to fight the war to give Americans what they really deserve -- a reasonably simple, fair and economically sound income tax.
It is as though Congress suffers from what I call SARTS (Self-serving Avoidance of Reasonable Tax Simplification) syndrome. This is a highly contagious disease, and a damaging one. It gave us all sorts of nuggets in the massive package of tax goodies passed two years ago -- like the $3,000 deduction for education expenses. However, this deduction was only made available from 2002 through 2005 and if you want to determine whether you're eligible for this itty-bitty deduction, you may be required to recalculate your income based on nine frighteningly complicated provisions in the code. Welcome to sections 86, 135, 137, 219, 221, 469, 911, 931 and 933.
Nutty rules like this one have left so many Americans dizzy that half of those polled in a recent survey said either that there had not been, or that they didn't know whether there had been, new tax legislation in 2001. How could they forget that $300/$550 rebate?! All those unemployed workers, all those bankrupt states, all those closed schools.
Single people had better start paying attention. The lawmakers' obsession with eliminating the so-called marriage penalty (could it be because married people tend to vote more often?) is unaccompanied by any outrage over the single person's penalty, the obligation of millions of single people to pay income taxes on an appallingly low level of income.
I'm not talking just about the rich. This is a story of low-, moderate- and middle-income households, too. Indeed, because so much commentary focuses on the disproportionate share of tax relief for the rich, the public has scant information to help it understand how the tax laws produce wildly inconsistent tax burdens for ordinary households. With about half our individual income -- a staggering $3 trillion -- legally protected from tax each year, the results could not be otherwise. A dazzling world of special exclusions, exemptions, deferrals, deductions and credits is accessible to many households through planning or sheer happenstance, and is inaccessible, or barely accessible, to other households. Yes, through the tax laws, Congress creates a society of winners and losers.
Consider the following two hypothetical households. First there's our single taxpayer. Let's call her Jennifer Adams. She's 33 and will earn $11,000 this year cleaning motel rooms. She takes the bus to work because she can't afford parking fees, rents an efficiency apartment for $400 a month, receives no work benefits beyond one week of vacation or sick leave (her choice), pays all her health insurance premiums and out-of-pocket health costs, and has no other income. Her modest earnings have prevented her from saving anything for retirement.
Then there's our married couple. I've named them Tom and Grace Chance. They're 31-year-old parents of 1-year-old twin girls. Tom will earn $66,000 this year as a full-time associate in a national accounting firm, plus $3,000 his employer will contribute to his 401(k) plan, to which Tom also will contribute $6,000 out of his salary. Grace will earn $11,000 as a part-time secretary.
It is Tom's good fortune that his employer also has a "cafeteria plan," which offers a rich menu of opportunities for him to avoid taxes on the portion of his wages his employer uses to pay many of his personal expenses. This year, Tom's menu -- totaling $16,000 -- will cover premiums for a family health insurance policy and a disability-income policy; out-of-pocket family medical expenses and parking expenses at work; and $5,250 (the maximum allowed under the rules) for college courses he is taking in late 19th-century expressionist art.
Tom and Grace own their four-bedroom house. They have mortgage interest, property taxes and state income taxes to pay. They also make small charitable contributions. These expenses will total $18,800 this year.
Congress believes only Jennifer should pay. Congress figures it's fair to tax her on her income above $7,800, even though the federal poverty level for people like her is $9,400. The Chances will be required to pay nothing even though their $80,000 earnings are more than 430 percent of the federal poverty level ($18,400) for a family of four.
I imagine you're standing on your kitchen table screaming "Has Congress lost its mind?!" To be fair, though, I believe that very few members of Congress would guess that the Chances would pay nothing. The law abounds with so many incongruities, contradictions and absurdities that it defies reasonable predictions of who will end up paying what.
Take the 10 education subsidies Congress has randomly crafted. They provide solid evidence of why Americans should insist that legislators curtail their efforts to engage in social and economic engineering through the tax laws. Rather than maximize the likelihood that people who can't afford college will be able to attend, most of the subsidies help people who would be likely to go to college even without the relief. For example, the largest subsidies, which can involve tens of thousands of dollars in tax savings, apply to wealthy parents or grandparents who stash $100,000 or more in tax-exempt state 529 plans and private college plans to pay for their children's or grandchildren's college tuitions; when the tuition is paid, the payments are also tax-exempt. Middle-class families rarely can set aside such large amounts. Low-income families can't afford to set aside any amount.
A Hope Scholarship credit ($1,500) and the Lifetime Learning credit ($2,000), which President Clinton championed to help ordinary Americans attend college, can help lower-income people who owe taxes. But for all those households who can't afford to send a child to college and don't owe taxes, the credits are worthless.
And then the final whammy. Economics 101 teaches that government subsidies increase the price of the thing subsidized, in this case higher education. People at the bottom of the income pole thereby get hit twice: They don't get the subsidies, and their education costs are higher than they would be if the subsidies didn't exist. The cost effect, of course, applies to everyone, which should make us wonder if any of the education subsidies, except those based on need, deserve to be in the laws in the first place.
If Congress were to vastly simplify the tax laws by providing relief only in the most compelling cases, it could bring down tax rates for everyone without sacrificing tax revenues. And if lawmakers stopped trying to micro manage our behavior through the tax laws and reduced taxes across the board, our economy would be stronger. So would the cash-strapped IRS, which recently announced that it lacks the money to collect $13 billion owed by taxpayers who could and would pay, if the IRS insisted.
Tax liability can be managed and in some cases, depending on individual circumstances, dramatically reduced.
When seeking to minimize tax burdens, investors should consider the four fundamental investment tax alternatives: tax-deferred, tax-free, tax-sheltered and capital gains. All tax planning strategies involve non-tax financial planning implications. Therefore, the key is to take advantage of those strategies consistent with other goals and objectives.
Former U.S. Appeals Court Justice Learned Hand once said, "Anyone may so arrange his affairs that his taxes shall be as low as possible. He is not bound to choose that pattern which best pays the Treasury. Everyone does it, rich and poor alike, and all do right; for nobody owes any public duty to pay more than the law demands."
For some investors, avoiding taxes is an all-consuming task. Others, however, consider tax implications only after a transaction is executed or a financial strategy implemented. There are those who view tax planning as a "Gordian knot" of complexity so great that only the very sophisticated can solve the riddle. Others, meanwhile have concluded that various changes in legislation through the years have only made updating tax strategies a never-ending financial frustration. Regardless of how you view taxes, tax implications should be considered with every financial decision. With the current tax laws, opportunities abound for investors to save.
Many who would like to lose weight wish for a "magic pill" to make the pounds simply melt away. They wouldn't have to change their eating habits, exercise more or do anything other than take a pill. Of course, we all know that there is no magic pill for losing weight. Similarly, there is no magic potion for making tax liabilities go away. All tax planning strategies involve one or more non-tax financial planning implications. Therefore, the key is taking advantage of those strategies consistent with other goals and objectives.
One might conclude that tax savings should be the primary goal of every investor. Rather than viewing tax savings as a financial goal, however, taxes should be seen as an obstacle to achieving financial goals. Wise tax planners seek out only those tax planning strategies that will help them achieve their goals.
In the grand scheme of things, income tax problems may not be bad problems to have. Individuals should make investment decisions after first considering whether the investment is appropriate for their needs. In addition, the fundamental economics of the investment should be sound. Then, tax considerations may come into play. Elevating taxes to the primary consideration will almost inevitably lead to bad investment decisions.
Those who consider their tax liabilities only as they are preparing their returns are most likely doomed to pay more in tax than the law requires. After all, only thinking about taxes just before year-end leaves 11 months of missed opportunities for reducing tax liabilities. Those who consider taxes only after a transaction is completed will find very few ways to reduce their tax liability once it is incurred. Tax planning is a proactive and prospective process. The earlier one begins, the more successful he or she may be.
Our current tax law is enormously complex, constantly changing and fraught with potential traps for the unwary. Therefore, a team approach to tax planning is important. A Financial Advisor's role is not unlike that of the head coach of a football team. The head coach's job is to develop the overall game plan. The role of the tax advisor, like that of a football defensive coach, is to analyze the suggested strategy's specific tax implications and approve its wisdom or suggest an alternative. The investor's role, like that of the quarterback, is to execute the strategy. We suggest you review all material tax strategies with your tax attorneys, CPAs or other tax advisors as appropriate.
The careful and thoughtful application of the foregoing principles of sound tax planning will not only serve to reduce tax liabilities but will do so in a way that makes achieving other goals easier.
On average, many Americans do not know the percentage of their income that goes to paying taxes. Most associate taxes with income taxes and rarely take into account Social Security tax, state sales taxes, and other non-income taxes. The chart below will enable an individual to estimate his/her "effective rate" of tax - i.e., how much income really goes to paying taxes of various kinds. It is important that individuals understand the impact taxation has on achieving their financial goals. In order to get started, an individual will need a copy of his/her most recent federal and state income tax returns, along with his/her W-2 and 1099 forms for the same year. To estimate the percentage of income paid out in taxes, fill in the amounts indicated below.
Gross Income
$__________________
This includes salary from all W-2s for both spouses, interest and dividend income from the 1099 forms, Schedule C net income,
and any income from partnerships, S Corporations, or other business interests that appeared on the income section of your return.
Your Total Federal Tax
$__________________
From Form 1040, Line 54-includes income tax, self-employment tax, and alternative minimum tax, if applicable.
Your total state income tax
$__________________
Includes amount(s) shown on state income tax returns. (None in Washington)
Your FICA Tax
$__________________
Write the amount of Social Security tax and Medicare tax withheld: this is shown on your W-2. Note that if you are self-employed, your self-employment tax (Social Security and Medicare tax for the self-employed) is included in the "total federal tax' item above.
Real Estate Tax
$__________________
From Schedule A of your tax return, or from real estate tax bill.
Sales Tax
$__________________
Multiply your Gross Income by 1/3 (an estimate of the average taxpayer's "disposable income'); then multiply that amount by the applicable sales tax rate for your state, county, city. (none in Oregon)
Total Taxes
$__________________
Add together all the taxes you have paid.
Effective Tax Rate
$__________________
Divide Total Taxes by Gross Income. This is an estimate of your effective tax rate.
It should be emphasized that this is merely a general discussion on estimating an individual's effective tax rate. If you are interested in completing a thorough analysis of your own tax situation consultation with a financial advisor or tax professional is recommended.
Just as financial planning decisions have tax implications, income tax decisions also have financial planning implications. When crafting a comprehensive financial strategy, it is critically important for an individual to select those tax saving strategies most consistent with achieving his or her overall goals. Intelligent tax planning is based on seven fundamental principles. We believe that, when successfully understood, they may help guide individuals to tax-smart decisions.
The first fundamental principle of effective tax planning is to understand how taxes affect investment returns. Analyzing the tax impact of an investment strategy requires the use of marginal tax rates. Under current laws, there are five marginal tax rates: 15%, 25%, 28%, 33% and 35%. These marginal rates apply at different levels of taxable income depending on an individual's filing status.
Consider the impact of marginal tax rates on investment returns. A hypothetical $10,000 investment that returns an average of 8% will increase almost $80,000 for a 38-year-old investor saving for retirement at age 65. However, imposing a 35% marginal tax rate reduces the investor's return over the same period to less than $40,000. This is a hypothetical example and is not intended to represent the performance of a specific security or portfolio. Investing involves risk and you may incur a profit or a loss.
Tax laws are complex and ever changing. In other words, while tax-saving opportunities still abound in the tax code, what worked yesterday may not work tomorrow. No one "best" tax-saving strategy exists. What is appropriate for one individual may not work for someone else. Furthermore, deciding whether a strategy is the "best" is usually only determined with 20/20 hindsight. Therefore, an investor may want to implement more than one tax-saving strategy just as he or she would diversify an investment portfolio among stocks, bonds, cash and real estate.
There are four fundamental investment tax alternatives: tax deferral, tax-free, tax shelter and capital gains.
Tax deferral involves paying taxes later rather than sooner. In the investment arena, there's an old adage, "a tax deferred is a tax saved" which still holds true today. Tax deferral can be achieved through various means, including fixed and variable annuity contracts, individual retirement accounts, employer-sponsored qualified retirement plans (e.g., profit sharing and 401(k) plans) and Series EE savings bonds.
Tax deferral is a strategy that usually benefits most from long-term deferrals and slow withdrawals. It may "backfire" if the deferral period is too short or if withdrawals are taken too fast. (Taxes are due upon withdrawal. A 10% IRS tax penalty may apply to withdrawals prior to age 59 1/2.)
Tax-free investment returns can be achieved through the ownership of bonds issued by states and municipalities. Known as municipal bonds, the issuance of these securities allows local governments to borrow the money they need for building schools, roads, police stations, sewer and water systems and a number of other projects. The interest on these bonds is generally exempt from federal income taxation. However, it may be subject to state, local or the alternative minimum tax (AMT). Tax-free cash flow can also be obtained from properly structured life insurance contracts.
Tax-free income makes the most sense for people in the 28% tax bracket or higher who have income as a primary investment objective. Please keep in mind, AMT rules can be tricky. Investors who do not anticipate the effects of the AMT may find themselves liable for a larger tax bill than expected. Investors should discuss the AMT with their tax advisors for expert advice on how the tax might affect their portfolios.
Tax-sheltered investments are those that provide cash flow which is fully or partially offset by deductions such as depreciation and depletion. The Tax Reform Act of 1986 sharply limited the once-abundant opportunities for tax-sheltered investments. However, current law still allows some opportunities in real estate, as well as oil and gas investments.
Investors should keep in mind that while investing in tax shelters provides the opportunity for considerable rewards, the exposure to risks can be just as great. In addition, tax-sheltered investments are not very liquid, making resale in the secondary market difficult.
Capital gains income receives favorable treatment under current tax laws. If capital assets (such as common stocks or mutual funds) are sold for a profit after being owned for more than one year, the profit is taxed at a maximum of 20%. Comparing that rate to the maximum rate of 35% on "ordinary" income - such as taxable interest and dividends - the capital gains rate has an almost 50% advantage. However, not all capital assets are sold for a profit. Some are more volatile than others, resulting in greater fluctuations in price.
Retirement planning decisions have tax implications. Most of the retirement plans available today, 401K, 403B, 457, IRA, are creations of the tax code designed to take advantage of tax laws. No one "best" tax-saving strategy exists. What is appropriate for one individual may not work for someone else. Furthermore, deciding whether a strategy is the "best" is usually only determined with 20/20 hindsight. When crafting a comprehensive financial strategy, it is critically important for an individual to select those tax saving strategies most consistent with achieving his or her overall goals. We believe that, when successfully understood, they may help guide individuals to tax-smart decisions. This is one of the most complex areas of tax planning - Retirement Planning encompasses tax planning, estate planning, Investment management, etc. Please choose the Retirement Planning option from the menu or Click here for more on Retirement Planning
Estate planning decisions have tax implications. Gifting, Living Trusts, Rabbi Trusts, Pooled Income Funds, Life Insurance Trust, First to Die Insurance, Second to Die Insurance; the options abound, astound, and confuse. No one "best" tax-saving strategy exists. What is appropriate for one individual may not work for someone else. Furthermore, deciding whether a strategy is the "best" is usually only determined with 20/20 hindsight. When crafting a comprehensive financial strategy, it is critically important for an individual to select those tax saving strategies most consistent with achieving his or her overall goals. We believe that, when successfully understood, they may help guide individuals to tax-smart decisions. Please choose the Estate Planning option from the menu or Click here for more on Estate Planning
Education Plan decisions have tax implications. Most of the education plans today, section 529 plans, Coverdell Education Savings Accounts (formerly Education IRA's), Savings Bonds; etc. are creations of the tax system. No one "best" tax-saving strategy exists. What is appropriate for one individual may not work for someone else. Furthermore, deciding whether a strategy is the "best" is usually only determined with 20/20 hindsight. When crafting a comprehensive financial strategy, it is critically important for an individual to select those tax saving strategies most consistent with achieving his or her overall goals. We believe that, when successfully understood, they may help guide individuals to tax-smart decisions. For more on Education plans please choose the Education Plans option from the menu or Click here for more on Education Plans
There are many benefits to donating to a worthy cause. Besides getting a warm fuzzy, the tax deduction associated with the gift can be quite beneficial.
This is only about rules regarding income tax deductions for gifts to charity, concentrating on outright gifts by individuals to charity. We will not cover corporate donations, gifts of non-capital gain property, partial interests and gifts of property for the charity's use. Charitable contributions is a very complicated subject - Click here for more information or choose the menu selection on Charitable Giving
Charitable contributions are subject to two limitations. The first limit depends on the type of charity and the second depends on the type of item donated.
Charities are broken down into two types, 50% charities and 30% charities. The percentage refers to the maximum percentage of adjusted gross income (AGI) that may be claimed in any one year. In order to claim an income tax deduction the charity, whether 50% or 30%, must be a United States charity. Fifty percent charities include churches, schools, hospitals, endowment funds for public universities, state and local governments, private operating foundations, private grant-making foundations and community chests. Thirty percent charities include veterans organizations, private non-operating foundations, fraternal organizations and public cemeteries. If you're unsure whether an organization is a qualified charity or whether it is a 50% or 30% charity, consult IRS Publication 78 which provides a listing of all recognized charities.
Gifts of capital gain property are subject to further limitations. To qualify as a donation of capital gain property the item must qualify for capital gains treatment (e.g. property held for investment) and must have been held for more than one year. Gifts of capital gain property to 50% charities are limited to 30% of AGI. Gifts of capital gain property to 30% charities are limited to 20% of AGI. Donations of capital gains property are valued at the fair market value at the time of the donation for all types of charities other than private foundations (under which tax treatment has varied). The taxpayer may elect to limit the value of his donation to his/her cost in exchange for a waiver of the 30% or 20% limitations.
The limitations are applied in the following order. First, all gifts to 50% charities, regardless of the type of property, are totaled. If they do not exceed 50% of AGI, gifts to 30% charities may be considered but they are limited both by the 30% limit and the 50% over-all limit. Then the capital gains limits are applied to 50% donations. Finally the capital gains limits are applied to 30% gifts. Unused deductions retain their character and may be carried forward for five years.
For example, John has AGI of $100,000 and made the following donations; $10,000 in cash and $40,000 in stock (basis $10,000) to his church and $5,000 to a public cemetery. His deduction equals $40,000 and consists of the $10,000 cash donation and $30,000 in stock. John has a carry over of $10,000 for the stock and $5,000 for the 30% charity. Take the same facts, except that his basis is $30,000. With the waiver election, his deduction is $45,000 consisting of the $10,000 cash, $30,000 basis (total of $40,000 to 50% organizations) and $5,000 to the public cemetery with no carry over.
Beginning in 1994, the new tax law bars a deduction for any contribution of $250 or more unless the taxpayer has written substantiation from the charity (canceled checks do not count) receiving the contribution, including a good-faith estimate of the value of any goods or services that have been provided to the donor in exchange for the gift. Substantiation isn't required if the donee files information with the IRS sufficient to substantiate the deduction amount.
Of course, this brief article is no substitute for a careful consideration of all of the advantages and disadvantages of this matter in light of your unique personal circumstances. Before implementing any significant tax or financial planning strategy, contact your financial planner, attorney or tax advisor as appropriate. Click here for more information or choose the menu selection on Charitable Giving
The alternative minimum tax (AMT) was created by Congress to help ensure that taxpayers, both individual and corporate, who enjoy economic income do not escape taxation through creative accounting and "over-use" of tax benefits provided under the regular tax system.
The AMT is actually a separate, parallel tax system with its own rules for determining taxable income, deductions and credits. The basic formula for the AMT is fairly straight-forward. The computation begins with "taxable income" as it is computed under the regular tax system.
This figure is then either increased or decreased, depending on circumstances, by AMT "adjustments." Next, AMT "preferences" are added. Then, the respective AMT "exemption" is subtracted. These "preferences' and "adjustments' are corrections designed to prevent high-income taxpayers from taking too much of an advantage of tax breaks that further economic or social goals.
The exemption amounts are much like personal exemptions under the regular system. For 2001 they are $49,000 for joint filers and $35,750 for individuals. There is also a phasing out of these exemptions if income exceeds certain levels.
The result of these computations is alternative minimum taxable income (AMTI). To arrive at the AMT, multiply the AMTI by 26% if the AMTI is under $175,000 and 28% for AMTI over $175,000. Finally, after deducting certain credits, the AMT is compared to the tax computed under the regular tax system. The taxpayer is then liable for the larger of the two taxes.
The interaction between the AMT and the regular tax system can make multi-year tax planning difficult. Consulting a financial planner or tax professional is probably a wise idea if you intend to engage in any significant tax planning strategy.
Towards the end of the year, investors begin to size up the performance of their investments for the year. Our winning positions, both realized and unrealized fill us with great pride and satisfaction while our losers sit there and stare us squarely in the face, making us turn our heads in shame. Attempting to take advantage of your losses may help you overcome them both psychologically and financially.
First let's cover the basics. Short-term capital gains and losses are incurred in a holding period of one year's time or less. Long-term gains and losses are incurred over more than a one year holding period. Short-term gains are subject to the individual's ordinary income tax rates, up to a maximum of 39.1%. Long-term gains are taxed at a more favorable 20% maximum, 10% for those in the 15% tax bracket.
The IRS allows taxpayers to match all short-term gains and losses against each other. Long-term gains and losses are also matched against each other. Any overall short-term gain or loss is then netted against any long-term gain or loss. If the result is a negative amount, no capital gains taxes are due and losses can be used to offset ordinary income up to $3,000 in the current tax year. Additional losses may be carried forward to be used in future years.
One last important note is the wash sale. A wash sale occurs when a taxpayer sells a stock at a loss and either has acquired or acquires during a period beginning 30 days before the sale and ending 30 days after the sale substantially similar stock through a purchase, taxable exchange or purchase of an option. If a wash sale occurs, no loss is recognized on the sale. The loss that would have been recognized, but for the wash sale rule, is added to the basis of the newly acquired stock.
With these facts in mind, we can examine tax loss selling as the government's way of letting you recoup a little something from the losses you have taken in the stocks you own. Tax-loss selling does not turn a loss into a gain, but it may put more post-tax dollars into your pocket. If you sell before the end of the year and turn paper losses into real losses, you reduce the taxes you owe on any profits you took during the year. Remember, this strategy is for taxable accounts only.
Psychologically, selling your losers to offset gains you have taken in your portfolio helps you to view the loss in a more positive light, sell the loser and move on. Losing investments sometimes cause investors to turn very stubborn. We don't want to admit that we chose a loser. Thinking of the loss as a positive may help. Or, if you are really convinced the stock is not a long-term loser, and that you just experienced unfortunate timing, you can sell the stock under the wash rules and re-purchase it 31 days later. You will take the loss and re-establish your position.
Here's a potpourri of rules and ideas that are important for year-end planning.
Securities Sales To realize a gain or loss in 2007, the trade date must occur on or before December 31. Settlement date is irrelevant for publicly traded securities.
The limit on the deduction of capital losses in excess of capital gains is $3,000. Any net capital losses in excess of $3,000 are carried over into 2008. Both short and long-term losses are counted on a dollar-for-dollar basis. A few years ago, long-term losses were worth only $.50 on the $1. No longer.
The holding period to achieve a long-term capital gain or loss is now more than twelve months. Count the period from trade date to trade date. Whether a gain is short or long-term does make a difference today. Net short-term gains are subject to a 39.1% maximum rate, while net long-term gains are taxed at a maximum 20%.
Retirement Plans If you are a calendar year taxpayer, the deadline for establishing a qualified retirement plan for deductions against 2007 income is December 31. The contribution need not be made until the filing deadline of the taxpayer's return. Note, however, that a SEP plan can still be established for 2006 deductions up until the return due date in 2007.
In order for a distribution to qualify as a lump sum distribution, 100% of the balance to the credit of the employee must be distributed in one taxable year. If you have retired this year, make sure that you have received (or will receive by year-end) everything you have coming under your former employer's qualified plan.
Charitable Contributions Many people make their annual charitable contributions during the holidays. If you're going to make a cash contribution, mail the check by December 31 to qualify for a 2007 deduction. Giving a personal note or I.O.U. to the charity won't qualify for a deduction, but donating with a credit card does.
Making gifts of securities is a very effective way to make charitable contributions. Charities are happy to receive odd lots. Donations of long-term capital gain property is deductible based on fair market value. It doesn't make sense to donate short-term capital gain property; you're deduction will be limited to basis. Also, it doesn't make sense to donate securities with losses; sell the stock and donate the cash. To claim a 2005 deduction, the security must actually be transferred to the charity before December 31. for more Information on Charitable Contributions Click here
Check in with your financial planner near the end of the year to see what deadlines and opportunities apply to your particular financial situation.
For your convenience we have the following tax tables available. These will popup a separate window so you can look at, print, or download them and then close that window without losing your place here
The setting of investment objectives for individual pools of assets is extremely important. However, it has traditionally been greatly complicated by misunderstandings due to differences of definition and interpretation.
The answers to the following questions will assist in establishing mutually agreeable goals and, at the same time, establish a framework for communications and mutual understanding in a client/investment manager relationship.
As always, you should discuss and coordinate tax-loss strategies with your financial and tax advisors. Remember, we all make mistakes. Turn your negatives into a positive.
NOTE: ALL information contained in this site is for illustration purposes only, and by NO means should be considered individual tax or legal advice under any circumstances whatsoever!
Lynn R. Siewert AIMC Pension Consultant | Branch Manager CA Insurance License #00B00579 2005 E. Evergreen Blvd Vancouver, WA 98661
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Therefore, a response to a request for information may be delayed. Please note that not all of the investments and services mentioned are available in every state. Investors outside of the
United States are subject to securities and tax regulations within their applicable jurisdictions that are not addressed on this site. Contact your local First Allied Securities office for information and availability.
