Taxes on the Exchange of Stocks

Taxes on the exchange of stock are only incurred if 1) the exchange leads to positive gains and 2) the transaction(s) do not take place within tax deferred financial instruments such as a Roth IRA. When earnings are made from the exchange of stock they are called capital gains and come in two types short term and long term. Capital gains are reported on an IRS form 1040, schedule D. There are several rules, and techniques that are relevant to and have the potential to lower taxation of profits arising from the sale of stock.

Short-term capital gains

Short-term capital gains are acquired through positive exchange of stock held less than one year in time. The taxation rate for short-term capital gains is the same as ordinary income taxation rates. For example, if one's total taxable income inclusive of short-term capital gains is between $30,650-$74.200, then income over $30,650 including the capital gains is taxable at 25% . Short -erm capital gains not held and/or exchanged in a tax deferred financial instrument are reported in part 1 of schedule D. This form is available at www.irs.gov.

Long-term capital gains

Long-term capital gains are gains made from the sale of stocks and/or other assets such as property that have been owned for longer than one year. The taxation of long term capital gains is lower than short term capital gains and is determined by completing part II of a schedule D in addition to part III of schedule D and the capital gains worksheet contained in the IRS 1040 instruction manual. The current tax rates for individually held long term stock capital gains as of the writing of this article is 5% for tax filers under the 25% taxable income bracket and 15% for taxable incomes at or above 25%.

Stock tax tips

There are several ways to legally avoid taxation of capital gains i.e. taxes on the exchange of stock. While these methods may not allow free and immediate access to the funds, they may serve as a viable tax hedge in instances where annual income is too high to make net worth and or leveraging outside of tax deferred financial instruments too costly in terms of taxation. It is also important to be aware of any special stipulations or rules within the tax code that may be helpful.

• Stock Transfers: Stocks transferred but not sold, from one account to another can allow the sale of stock in the new account to be taxed at a lower rate if the individual or organization receiving the stock is a child, has lower taxable income or is a non-profit organization.

• Donated Stocks: Transfers may also be considered tax deductible charitable contributions in the case of stock transfers to non-profit organizations or trusts.

• Wash Sales: If stocks are traded more than once within a 30 day period and at least one of the sales resulted in a capital loss, that loss is not deductible as a capital loss and is known as a "wash sale".

• Non-Taxable Distributions: For stocks that also pay special dividends or qualify for dividends to be distributed as non taxable, capital gains can be offset by the cost of stocks in so much as the non taxable distributions have a value equal to or less than the original cost of stock.

• Retirement Accounts: Exchange of stock through a retirement account can be tax deferred meaning any capital gains acquired through the account will not be taxable until withdrawal of that income.

• Irrevocable Trusts: If a stock owner gives stocks to trust before the stock increases in value then 1) one's taxable income will be lowered by the amount of the trust donation if the trust is non-taxable 2) the stocks within the trust may be tax free after sale, if they are less than the estate tax minimum taxable amount and 3) Dividend income earned through the stocks in the trust may also avoid taxation.

• Capital Losses: In cases where net taxable income is just over a new tax bracket for a given year, it may be advantageous to sell at a capital loss if one's investments in tax deferred instruments such as deductible IRA's have been maxed out and if the capital loss is likely to be unavoidable. This in a sense lowers the amount of the capital loss via tax savings between approximately 10%-33% on each dollar of capital loss provided a taxable income exists.

Taxation of capital gains can be thought of as quite straightforward in comparison to some other taxation concerns. Generally, short-term capital gains are not as cost effective as long-term capital gains and in the case of investments sold through a retirement or tax deferred financial vehicle. Some exchanges of stock, such as "wash sales" may not be deductible and capital losses may be offset through certain non -taxable dividend distributions. Other ways to reduce tax on stocks is to transfer ownership of them to a child or non-profit organization before the exchange.

Sources:

1. http://www.irs.gov/publications/p550/ch01.html#d0e4968
2. http://taxes.about.com/od/capitalgains/a/CapitalGainsTax_4.htm
3. http://www.msnbc.msn.com/id/7070269/
4. http://www.inc.com/magazine/19970901/1322.html