 |
|
To print article, click Print on your browser's File menu. Go back |
|
Recent articles by Jeff Schnepper: • Can you turn to the IRS for tax help?, 12/1/2005 • Last chance to save on your taxes, 11/29/2005 • Got long-term stock gains and losses? Lucky you, 11/13/2005 More... |
|
Related Articles The tax traps of working at home Need a tax pro? Ask yourself three questions Related Resources Visit our Taxes home page Try the MSN Money tax estimator Need a deduction? Look it up on our deduction finder |
| The Basics | |||||||||||||||
| Share your investment losses with Uncle Sam | |||||||||||||||
|
The tax code is built to let you use the money you lost to minimize your tax bill. So be patriotic. Put that law to work and save money at tax time. By Jeff Schnepper This is a time to stand up for your country -- the great United States of America. Im proud to live in a nation that has allowed me the opportunity to work my way out of the slums of East New York and earn an income that mandates quarterly tax payments, each five times the total income my father earned in a whole year. In fact, some people are so proud of this nation that they actually make voluntary (and deductible) tax contributions to reduce our national debt. Voluntary contributions to the U.S. Debt Reduction Fund since 1961 have totaled almost $40 million. But I must confess that I empathize with the late entertainer Arthur Godfrey, who once remarked, I am proud to be paying taxes in the United States. The only thing is, I could be just as proud for half the money.
The question then is, can we continue to be proud and bring our tax bills down to something closer to half the money? Sure -- with good tax planning. Let's take a look at two areas that loosely come under the umbrella of investing. Elsewhere on MSN Money, we look at those bread-and-butter tax saving moves you should make before Dec. 31 every year. Youll also find a checklist of things to remember about your taxes. And when were all done, try out what weve discussed on the MSN Money tax estimator. Share the loss Let's say you have a loss in your stock portfolio. Heres a chance to share some of that pain with your friends at the Internal Revenue Service. My general rule with investments is that if you wouldnt buy the security today at its current price, its time to think about selling it.
Sell those securities before Dec. 31, 2005 and capture the tax benefit of the reduction in price. If you believe the shares have substantial potential future appreciation, you can have your cake and eat it too. It's easy: Repurchase the stock (or fund) after locking in the loss deduction. But beware of the "wash sale" rules. These rules disallow any current deduction if you buy the stock (or fund) either 30 days before or 30 days after the loss sale. So wait 31 days after your loss sale to escape this tax trap. One way to avoid the wash sale rules may be to sell the losing security in your taxable account and then immediately repurchase it in your IRA or qualified retirement plan. Since these plans constitute entities "separate" from "you" for tax purposes, the wash sale prohibition shouldn't apply. One last point: Capital gains rates. Congress cut tax rates on most investments (i.e., stocks, bonds, real estate -- but not fine art) held for more than a year in the 2003 tax law. If you're in the 15% bracket or lower, the rate on long-term capital gains is 5%. If you're in the 25% bracket or higher, the rate is 15%. if you held the investment for less than a year, you're taxed at ordinary income rates. Municipal bond swaps. If you own tax-free bonds that have fallen in value, consider a municipal bond swap. Thats a strategy where you sell your loss bonds and buy equivalent, but not identical, bonds to replace them. You maintain the same risk exposure and yield, but, because the bonds arent the same, you avoid the wash sale limitations. You get the same cash flow from the interest payments and the same full principal at maturity. But you also now get a tax deduction. Its a win-win situation for everybody, except the IRS. Minimize the hit from the Alternative Minimum Tax What can be more fun than watching your portfolio dissolve and then finding you have to pay taxes on dollars you no longer have? Welcome to the netherworld of the Alternative Minimum Tax (AMT). The AMT is a special add-on tax. The IRS slaps you with it if you take too many deductions in specific categories (called "preferences") or if you engage in certain specified activities. Its a flat 26% or 28% tax on an augmented Alternative Minimum Taxable Income. One of those "preferences" is the spread between the exercise price and the fair market value of stock acquired under an Incentive Stock Option Plan. So, if the exercise price is $100 per share and you exercise your incentive stock options when the stock has a fair market value of $250, the $150 difference may subject you to the AMT. Thats discomforting when the stock is at $250, but if the stock drops to $75, its an absolute disaster! Youve not only lost your appreciation, but your investment is worth less than what you originally paid. And then, here's the capper: You have to pay additional tax. What can you do? Take a deep breath and recognize that under the AMT, any additional income you earn will be taxed at a 26% or 28% rate. If youre normally in a bracket higher than that, this is the time to accelerate income. Consider taking that bonus this year rather than next year, when it may be subject to tax at a higher rate. If youre self-employed, send out your end-of-year bills in November rather than at the end of December. Clearly take that additional earned income if youve hit the ceiling on Social Security contributions. For 2005, any earned income that exceeds $90,000 wont be subject to Social Security. (The level rises to $94,200 in 2006; the limit is adjusted every year for inflation.) If youre self-employed, that saves you 12.4% in taxes you wont have to pay. If youre an employee, the savings drop to 6.2% but thats because your employer would be liable for the other 6.2%. Alternatively, defer taking any deductions. If youre subject to the AMT, those deductions will save you only 26% to 28%. Deferring them into next year, when you wont be subject to the AMT and will be in a higher tax bracket, will put more money in your pockets. Yes, these suggestions are the exact opposite of what is normally suggested. But the AMT puts you into another dimension where the rules are reversed. For more information on the AMT, see my article Don't get bitten by this Awfully Mean Tax . | |||||||||||||||
| |||||||||||||||
MSN Money's editorial goal is to provide a forum for personal finance and investment ideas. Our articles, columns, message board posts and other features should not be construed as investment advice, nor does their appearance imply an endorsement by Microsoft of any specific security or trading strategy. An investor's best course of action must be based on individual circumstances.