Investing and TaxesInvesting and taxes is one of the most important things to consider when selling your stocks for a gain. Congress is currently working toward extending the specail tax rate for capital gains and dividends to 2010. It is suppose to expire in 2008. If you're new to investing, please know that taxes are part of investing and there is no getting around it. There are two ways you get taxed from investing in stocks. 1. Captial Gain Tax Captial Gain TaxA capital gain is when you sell an assets for a profit. It could be a house, land, stock or bond. Let's stick with stock investing and taxes in this example.You figure the capital gain tax on the difference between your purchase price and the sales price. The difference is your profit or loss. The purchase is usually what you paid for the stock. If the difference between the purchase and the sale is negative, then you lost money, you have a capital loss, which you can use to offset capital gain. There are two types of capital gains: Long-Term Capital Gain Understanding the difference is very important.
Long-Term Capital GainYou must hold the stock at least one full year to qualify for the long-term capital gain rate currently at 15% if you are in the 25% income tax bracket or higher. 5% if you are in the 15% or lower tax bracket. This is extremely important and I urge you to make absolutely sure to hold the stock for at least one year to be safe since investing and taxes can and will lower the amount of money in your bank account or brokerage account. Short-Term Capital GainIf you hold a stock less than one year before selling it, the IRS classifies the sale as a short-term capital gain and taxes the profit as ordinary income, ouch! This means you could pay 25% or much higher of your profit in taxes. Unless you are a day trader or for any other reason try to hold onto your stock for at least one year. Long enough to qualify for the long-term capital gain rates. I learned this valuable lesson the hard way. I thought I was Mr. Stock since I was getting 50% or more gains on some of my trades. But only to learn that I was going to get creamed by the IRS. I went to do my taxes and my tax advisor saw my statement from Ameritrade he looked at me and said, "are you aware that you'll have to pay ordinary income tax on all your trades/gains?" I looked at him like he had three heads, but then he educated me that I need to hold stocks for a year in order to qualify for the 15% rate. I did not know at the time so be careful and consider the tax implications when investing in stocks. This one little piece of advice that can save you hundreds or thousands of dollars. It's a good idea to buy good quality stocks and hold them for the long term. Let's invest like Mr. Wareen Buffett, he's a long term kind of guy. I'm sure Mr. Buffet takes advantage of investing and taxes with a good management team that oversees his accounts or businesses.
Dividend TaxCompanies that distribute profits through dividends creates a taxable event for you. The IRS taxes dividends at 15%, but this is a tax-relief provision that could expire in 2008 if not renewed. Otherwise, dividends may be considered ordinary income and taxed at your current rate. There is not much you can do to avoid some taxes on dividends, unless you hold your stock in a qualified retirement plan and have the dividends reinvested in your plan. Investing and taxes go hand in hand, educate yourself and always read to keep up to date on these important and critcal rules that are in place. Tax PlanningIf you make sure that all of your capital gains qualify as long term, your next possibility is to look at any losing stocks you may want to dump. You can take a capital loss in the same year you have a gain and offset it. Most investors use this approach to lessen that tax impact of their gains. This is the reason that the stock market may go down toward the end of the year as investors dump losing stocks to offset gains. However, don't sell a stock just for tax reasons. If there is good reason to expect the stock will rebound, it doesn't make much sense to sell it. You can claim upto $3,000.00 in capital loss per year. So if you lost $5,000.00, you can use the remaining $2,000.00 the following year. A lot of people forget this all important tax benefit, if you consider it tax benefit. Also keep in mind that your commissions charges on all your buy/ sell of stocks is tax deductible. However, you tax advisor should know this, but have him explain to you all the details as he/she does your taxes. Keep learning and ask questions especially with investing and taxes.
Wash RuleThe IRS has a rule in place to prevent investors from selling a stock in a losing position to offset a gain, only to turn around and buy the stock right back. It is called the "wash rule" and it says you can't sell a stock and buy it back within 30 days and claim a capital loss. If you sell a stock and buy it back within 30 days, the IRS will disallow the capital loss and you will lose the offset. In conclusion, if you are careful you can keep the taxes to a minumum, however always seek good tax advice with questions about complex tax questions. Invesing and taxes go hand in hand there's no way around it.
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