The idea behind investing is to make a profit. I fully support the idea. But I'm a tax accountant, and I know that Uncle Sam's appetite for tax revenue can affect how much money you actually realize from your investments.
And I know one other thing: Uncle Sam wants you to make money from your investments and throws more than a few bones at you as incentives.
So, to get the tax code to make your investments work harder for you, I offer seven ways you can use Uncle Sam to maximize your gains, minimize your losses and, when necessary, reap the biggest deductions.
Time your sales for the lowest taxToday, there is a monstrous difference between the tax on long-term capital gains and the tax on other income. The rate on long-term capital gains may be as low as 0% for 2009 and 2010 -- if you're in the 10% or 15% tax brackets. With the sale of stock, it can't be any higher than 15%.
Short-term capital gains are taxed at your regular income rates -- as high as 35%. That's a 20-percentage-point difference. On a gain of $10,000, that means $2,000 more in your pocket.
To qualify as long term, a security must be held for more than 12 months.
Let's say that, by early December, the price was $150. You were looking at a pretax gain of $100,000. But you expected the stock price to crater soon, and you wanted to get out before it did. What would have happened if you'd sold then?
You'd be in short-term-capital-gain purgatory. You'd pay as much as $35,000 to protect your gain. With proceeds of $150,000, you'd be left with $115,000.
But what if you had waited? Say, for example, that you didn't sell until mid-January, after the stock had fallen below $140. That drop cost you $10,000. But what's now a $90,000 gain would be taxed at no more than 15%. That's $13,500 off your $140,000 proceeds, leaving you $126,500.
Did it pay to wait? You bet: You ended up with $11,500 more than if you had sold before the year's end.
Or you could have bought a put option -- the right to sell at a given price -- and insured your gain.
Time your stock buys to avoid wash salesWash sales apply only to losses. If you sell a security for a loss and buy or have bought a substantially identical security within 30 days either before or after the loss sale, you can not deduct that loss until you sell the new security. Technically, the loss amount is added to the basis of the new shares.
This is a nasty trap for the unwary.
How to avoid it? Easy. Pay close attention to the calendar. Don't buy until the 31st day.
Time your mutual fund buys carefullyIf you own a mutual fund, you're taxed on your share of any of the funds' inside gains from dividends received or stocks sold. (An inside sale occurs when a fund sells a security out of its portfolio.) But the fund looks at its books only once a year to determine who actually owns the shares of the fund. Those people get the dreaded 1099s.
That date is called the date of record (or record date). If you're found on the books on the date of record, you pay the tax on the whole year's gain.
So, if you bought the fund on Dec. 1, and the date of record is Dec. 10, you're going to have to eat the tax on the full year's gains. That's only half the hit. When you bought on Dec. 1, the price you paid probably included most of the gain. So, you're actually paying tax on gain that you bought and already paid for.
So here's Schnepper's rule: Before you buy any fund, always find out its date of record. Then carefully time your buy. A few days' wait can save you a substantial tax hit.
Don't automatically fund your IRAOK, I know that's the complete opposite of what everybody else recommends. But sometimes the "best" advice isn't really the right advice for you.
Let's say you're in the top tax bracket now, and you expect to be so at retirement. Any distribution from your IRA or other qualified retirement plan is going to be ordinary income that's taxed at today's maximum 35% rates. Current tax rates are now the lowest I can remember. With exploding deficits creating a continuous need for new revenue, I can see tax rates moving only higher. President Barack Obama has promised higher rates for those in the top tax bracket.
So you may pay a lot more than 35% on your retirement distributions.
Say you've got a $100,000 gain on your investment when you retire. That minimum $20,000 in tax savings would pay for a whole lot of tax deferral and a current $3,000 deduction. It's at least another point of view.
Invest in US savings bondsOur government really wants your money. Even if it has to borrow to get it.
Lots of tax savings here:
- You can defer the income on a federal basis until you redeem the bonds.
- On a state level, it's even better. The income is tax-free.
Don't forget the break that savings bonds offer middle-income families on education expenses. You may be able to exclude the interest income on your federal income taxes if you redeem your bonds in a year when you also pay for qualified higher education expenses. Unlike borrowing to invest in a business, where you have to show how the money is used, there's no one to trace what you do with the savings-bond cash. You don't even have to use those exact dollars to get the deduction.
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- 5 ways to avoid an audit
- Prepare for your tax preparer
- Got long-term stock gains and losses? Lucky you