As year-end 2006 approaches, tax planning can maximize your stock market investments

An important component of strategic tax planning is the role of your stock market investments. Initially, the tax planning strategies may seem daunting in their complexity but when broken down into their component parts, they can be quite simple. Our office can help design a year-end tax plan that reflects your goals as an investor.

Important fundamentals

First, let’s take a look at some general rules that are common to a variety of strategies that arise in connection with investments in securities:

  • Generally, the maximum capital gains rate is 15 percent for sales of capital assets (five percent rate for those in an ordinary income tax bracket of 15 percent or less).
  • Reduced income tax rates make tax-exempt investments less competitive.
  • If you have only short-term capital gains, these gains are taxed at ordinary income tax rates.
  • Generally, collectibles are taxed at a capital gains rate of 28 percent. Collectibles include gems, stamps, coins and antiques.
  • Most dividends are now taxed at the same low rate as net capital gains.
  • Capital losses in excess of capital gains may be used to offset $3,000 of ordinary income. You may carry over unused losses indefinitely.
  • Installment reporting is not allowed for sales of stock or securities traded on an established market. Furthermore, gain or loss is determined as of the trade date rather than at the settlement date.
  • You also need to keep in mind the “wash sale” rules. We’ll talk more about these later.

Different strategies for different taxpayers

Keeping in mind all of these factors, here are some strategies you can consider:

Securities with short-term gain:

  1. Sell for the gain: Where losses (including carryovers) are sufficient to offset gain and obtain a $3,000 offset against ordinary income.

Securities with long-term gain:

  1. Sell for gain to achieve a lower tax rate: Net capital gains are always taxed at a rate lower than your wage and other ordinary income. However, capital gain is income fully included in your “adjusted gross income” that may determine your qualification for certain tax deductions and credits.
  2. Sell for a gain to be able to make use of losses: If you have losses or loss carryovers, you may want to make use of them above the $3,000 limit. You may re-purchase immediately without tax liability.

Securities with long-term loss:

  1. You may consider selling to offset already-realized gains dollar-for-dollar, saving the tax on such gains.
  2. You may consider selling to realize at least $3,000 of losses in excess of gains for the maximum $3,000 offset against other income.
  3. Alternatively, you may consider selling for additional loss to establish carryover of long-term loss for subsequent years.

Securities with short-term loss:

  1. You may consider selling to offset short-term gains and save the tax on such gains.
  2. You may also consider selling for additional loss to offset long-term capital gains.
  3. Alternatively, you may consider selling for up to $3,000 of losses in excess of gains for a tax-saving deduction from ordinary income or selling for additional loss to establish carryover of short-term loss for subsequent years.

Wash sales

The wash sale rules are potential traps for the unwary and they have to be recognized when designing your strategic tax plan. Basically, if you sold any stock, bonds, or stock options at a loss and then purchased substantially identical securities within 30 days before or after the sale, the loss on the sale will not be deductible. The loss will be ignored because your sale was a “wash.” This rule applies whether you sell and re-purchase from different brokerage accounts or the same one.

The news is not all bad. You can add the disallowed loss to the basis of your new investment, so that you are not in a worse position than you were before the sale (except for any brokerage fees on the sale, of course). Moreover, you can add your holding period for the old stock to that of the new stock, for purposes of determining the holding period when you eventually sell the new investment.

The wash sale rules are also important in the context of short sales. Many very technical rules apply to short sales, straddles, and to sales of options and commodities. If you are involved in any of these types of investments, you must pay special care to the complex rules when designing your strategic tax plan.

Year-end advice

Year end is an ideal time for “tax selling” since you have a fairly clear picture of how your portfolio and the markets will look at the end of the tax year. As year-end approaches, we encourage you to contact our office to discuss how your investments fit into your strategic tax planning. As always, we are just a phone call away.

IRS CIRCULAR 230 REQUIRED NOTICE
IRS Regulations require that we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended to be used and cannot be used, for the purpose of avoiding penalties under the Internal Revenue Code or for the purpose of promoting, marketing or recommending to another party any transaction or tax-related matter.