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

An Overview of Capital Gains Tax Rules

The Capital gains tax is the government portion of profit(s) made from the sale of assets in the form of tax. Depending on how high one's capital gains are for a given fiscal year, capital gains tax can vary from between 0%-28% in the United States.

If capital losses are incurred on the sale of assets, those losses if combined with capital gains to be a net loss, can be deducted from total income possibly placing the tax filer in a lower tax bracket. This article will illustrate 1) the concept of the capital gains tax, 2) where to find information about filing capital gains tax and 3) tips that may be helpful when preparing for capital gains or losses.

What Capital Gains Tax is

In addition to being a tax on the profitable sales of assets, capital gains tax also applies to investments. Consequently, profitable sales of stocks, commodities, mutual funds, real estate, classic automobiles, bonds, collectibles etc. are all considered capital gains when sold from a non-commercial entity, i.e. individually and not through a business.

The U.S. Internal Revenue Service classifies assets and investments that qualify for capital gains and losses slightly differently. For example, losses on personal property such as non-investment vehicles or homes are ineligible for a capital loss deduction according to the IRS. Additionally, there is a limit of $1500-$3000 to the capital loss deduction

Information on calculating and filing capital gains tax

Assets and/or investments that are held for one year or longer qualify for long-term capital gains tax whereas assets and investments held for less than a year are considered short term capital gains. (www.irs.gov). Short-term capital gains are legally subject to higher taxation rates than longer term capital gains.

Each year tax code may change through adjustments to tax code so tax rates can vary. Generally, the exact tax can be calculated using a capital gains tax calculator, and/or referring to IRS Publication 550 "Investment income and expenses (including capital gains and losses)"

After completing an IRS Schedule D and form 1040, one should be left with the correct amount of capital gains and/or loss to which tax, if any is applied. It is not until this value is calculated that a capital gains tax assessment can be made. Generally speaking, the higher the capital gains, the larger the capital gains tax will be, especially if the gain is over $28,000.00 (IRS Publication 550)

To illustrate, if Mr. Jones earns $50,000 in capital gains, and all these capital gains where from short-term holdings, that income will be added to his additional income if any on his form 1040 unless he invests through a business. If his gross adjusted income is above $75,000 his capital gains will be taxed at the highest amount because the capital gains were short term holdings, thus subject to higher taxation up to 28%, and his income tax bracket is at the 28% level.

Tips and techniques for recording capital gains and losses

Preparing for capital gains tax can be a year long process, accurately recording costs, profits, losses and investments bought and sold can assist in cross referencing and recording proper numbers on the IRS forms. Additionally, if a form 1099 is sent by a broker, the values on that form can be compared with personal records.

Additional examples of sales records include checks with memos, title transfers, transfer of deed and certificates of ownership. In the case of Roth Individual Retirement Accounts, capital gains earned through investment through the Roth IRA are tax deferred and therefore do not need to be recorded in a tax filing until withdrawal. The following tips may be helpful with working with capital gains.

• Read the tax code provided by the Internal Revenue Service: This helps identify what capital gains levels are taxable at which rate and may help lower tax.

• Properly deduct investment losses from capital gains so as to avoid over taxation

• Consider investing through a retirement account to avoid annual schedule D filings and capital gains tax before annuity or IRA distribution.

• If investing through a retirement account, capital gains within a Roth IRA may be non-taxable if the proper withdrawal criteria are met. (bankrate.com)

•If investing through a foreign owned corporate trust, capital gains tax rules may be lower.

•Investments through insurance policies may avoid capital gains tax through loans made from the policy and/or if the total cash value of the loan amounts to less than the total cost of financing the policy (babyboomercaretaker.com) Also, in the event of death or a claim on life insurance, the value of the policy is often not taxable.

Summary

Capital gains are a way for the government to tax income from the profitable sale of investments and assets. The tax rate for capital gains varies based on the 1) tax code for any given year 3) amount of capital gains in relation to individual income and 3) the financial vehicle and/or entity through which capital gains are earned. If capital gains are taxable in the United States, the Internal revenue service publication 550, form 1040 and schedule D are essential documents that may be referred to and/or completed in properly filing capital gains with the Department of the Treasury's I.R.S.

Sources:


1. http://www.irs.gov/newsroom/article/0,id=106799,00.html
2. http://www.irs.gov/pub/irs-pdf/p550.pdf
3. http://www.moneychimp.com/features/capgain.htm
4. http://www.bankrate.com/brm/news/drdon/20011129a.asp
5. http://taxes.about.com/od/capitalgains/a/CapitalGainsTax.htm
6. http://tinyurl.com/663scfz
7. http://www.moneychimp.com/features/tax_brackets.htm

Taxation of Capital Losses

Capital losses are the adverse circumstance that most investors don't like i.e. a loss of capital arising out of the sale of an asset that has lost value. Examples of capital losses include the sale of a home at a lower price than one bought it for, and loss on the sale of stocks. As bad as capital losses are there is actually a good side to capital losses and that has to do with their taxation.

Capital losses are tax deductible

The best thing about a capital losses are they can be included among allowable tax deductions. When one loses money through the sale of an asset that has lost money that loss can be deducted of a tax filers annual income. For example, if John Doe earned $51,000.00 in year Y, but also lost $5,000.00 on the sale of his home, he can deduct the $3,000.00 from the $66K making his annual income $48,000.00

Another good thing about the tax deductibility of capital losses is that they may lower one's adjusted gross income to an income tax bracket they would not have been in had they had a capital gain or no capital loss. When one is close to the cusp of tax brackets, capital gains between $1-3000.00 may be redundant since a capital loss of the same amount could save one a similar amount of money in taxes. That is to, say when in the tax cusp sell at a loss to avoid higher taxes.

Illustrating cusp taxation

To illustrate how selling at a loss can be good consider the following example. Since John Doe earned $51,000.00 in year Y, it is looking like he may end up in the 25% tax bracket after deductions. Moreover, without the capital loss, John Doe may only be able to utilize his standard deductions and federal tax exemptions, which can be around $17,000.00 if John Doe has no children and is married filing jointly.

This makes is adjustable gross income $36,000 which doesn't qualify for the 15% income tax. However, with the capital loss deduction of $3,000.00, John Doe's income is now only taxable at 15% which is approximately $4650.00 of tax as opposed to $9000.00 at the $36K level. So even if John Doe had a capital gain of $3K or no gain at all, being in the lower tax bracket has saved him around $5000 in taxes which is better than $3000 in capital gains or no gain at all.

The value of capital loss

Tax filing status can have a direct impact on the maximum tax deductibility of capital losses. For example, the capital loss deduction is higher for married persons filing jointly than for singles i.e. in 2007 the maximum deduction was $3,000 versus $15,00.00 so any loss greater than these amounts is a worse loss.

Additionally, capital loss is not always a losing scenario. If one's capital loss is only $2000.00 but one is still in a higher tax range or not in the cusp, that person still saves in taxes a percentage of the amount one would have had in income had the capital loss not occurred. In other words, $250.00 in taxes if one is in the 25% range with a deduction of $2000,00 or $280.00 if in the 28% tax bracket. Thus, the tax system actually lowers the monetary value of the loss by 12.5-14%