Year-Ending Money-Saving Ideas and Planning for Securities Transactions
As we approach year-end, it’s again time to focus on last-minute moves you can make to save taxes – both on the current year’s return and future returns. While proposed transactions might save taxes, such transactions normally should be made with economic, business, and personal financial objectives in mind. Generally it is best to look out at least two years in advance and think about how a transaction this year might affect the tax situation next year.
Capital Gain Rates 2008 to 2010
What about gifts of appreciated securities, if you have any left, to children?
Long-term capital gains and qualified dividends which fall into the 10% to 15% tax brackets will not be taxed. In other words, the tax rate is zero. This will be the case to the extent your taxable income does not exceed $65,100 on a joint return or $32,550 on a single or married-filing joint return. Given the 2008 Presidential election results, whether the zero percent tax rate remains in the law after 2008 is anyone’s guess. However, they are in effect for 2008. So gifts of appreciated securities to lower bracket taxpayers makes sense, especially if made to college-bound children, but only if the Kiddie Tax situation is dealt with.
Warning: Generally, the Kiddie Tax can be dealt with by planning to have the child receive earned income in the year in which long-term capital gains and qualified dividends are received at least equal to the support of the child. Since support is not an easily pinned down value, erring on the upside is the best policy.
Warning: Gifting of securities in excess of the annual gift tax exclusion ($12,000 in 2008 and $13,000 in 2009) will result in having to file a gift tax return and using part of the $1,000,000 lifetime gift tax exclusion.
Harvesting Capital Losses
Take losses early and let gains run is a good rule for tax policy as well as investment policy.
Capital losses are fully deductible against gains and an additional $3,000 of losses on a joint return ($1,500 on a single or married-filing separate return) are deductible against ordinary income, such as salaries, wages, interest, dividends, business income, etc. Any balance of unused losses are carried over indefinitely, except if the taxpayer dies when not in a joint return filing status. Then, they are lost. Taking losses before the so-called tax season begins, makes a lot of sense because you want to maximize the loss carryovers but minimize the economic/investment loss. This comment applies only to taxable accounts. Realized losses in retirement accounts are not deductible according to Revenue Ruling 2008-5,.
When planning how much to realize in losses, take into consideration what if any capital gain distributions might be coming from mutual funds you own.
When a decision to realize losses has been made, consider identifying which lots to sell, if selling only part of a holding. Designation of which lot to sell is made by notifying the brokerage firm. Generally, you would want to designate the highest cost shares.
Wash Sale Rules
Ignoring these rules will result in disallowance of any realized loss
The tax rules regarding allowance losses on sales of securities say that a loss is disallowed for federal income tax purposes if, within the period beginning 30 days before the date of the loss sales and ending 30 days after the date of the loss sale, the taxpayer buys “substantially identical” stock or securities. In the case of such disallowance, the loss is added to the cost basis of the loss security bought or sold as if no economic transaction took place.
The way taxpayers can be “trapped” by this rule is when taxpayers sell a security or mutual fund in December to realize a tax loss and buy back the security or mutual fund in January in order to maintain the position. Most brokerage firms will pick up on this. The IRS does not always detect wash sales except under audit. Another way to run afoul of the wash sale rule is to use a related party or a IRA account to repurchase the security or mutual funds.
What Does “Substantially Identical” Mean?
Good question and nobody knows
Since the wash sale disallowance rule only applies when “substantially identical” securities or mutual funds are transacted, what does that phrase mean? The IRS has issued no guidance other than to say (in IRS Pub 550) that “all facts and circumstances must be considered in making a determination.” Accordingly, no one really knows, so tax practitioners make educated and reasoned guesses. The IRS has issued one revenue ruling, Revenue Ruling 2008-5, dealing with the limited situation of an IRA account buying back stock sold in a taxable account, but that’s it.
So, let me try to make some educated guesses of what the IRS would do in an audit:
1) A repurchase of fewer or more shares of the same security or mutual fund will be treated as a wash sale.
2) A repurchase by a related party, particularly another family member, of the same security or mutual fund will be treated as a wash sale.
3) A repurchase of the same security or mutual fund by a 401(k) retirement account would probably be treated as a wash sale, although there is no IRS guidance on this issue.
4) A repurchase of a different security or mutual fund in the same investment sector (energy, agriculture, industrial, retail, etc.) might escape wash sale treatment.
5) A repurchase of a different mutual fund in the same asset category (large cap, midcap, small cap, real estate investment trusts, bonds, etc.) would probably escape wash sale treatment because no two mutual funds hold exactly the same securities in exactly the same proportion. However, there is no IRS guidance on this issue.
6) Short sales of the same security within 30 days of a purchase or sale transaction, will absolutely be treated as a wash sale by brokerage firms, based on my personal experience.
In certain situations, such as item 3) above, the brokerage firms will probably not be able to track and “fix” a wash sale transaction, especially if the 401(k) plan is with a different brokerage firm. However, obedience to the tax law is calculated to promote better sleep at night as well as peace of mind and the character trait of integrity.
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