Investors - Minimizing Taxes On Investment Income
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Bob Parrish CPA, P.C.
Longboat Key FL; Odessa TX
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Wednesday, September 22, 2010 02:17 PM
Long-term capital gains
Long-term capital gains are the profits from the sale
of capital assets (such as stock or other investments) that you held for more
than one year. The net long-term capital gains (profits made after subtracting
any capital losses) receive special treatment. The maximum tax rate that you pay
on such gains is limited to 20%, regardless of your tax bracket.
For people in higher tax brackets, the maximum tax
rate on long-term capital gains offers some huge advantages, showing that
patience can pay.
So use the capital gains and losses rules to your
advantage. Both long-term and short-term capital losses are allowed to offset
any capital gains on a dollar-for-dollar basis. The excess losses reduce your
other (ordinary) income. The maximum you can deduct in any given year is $3,000,
however. Any losses that exceed the $3,000 limit can then be "carried
forward" into future years until you have fully written off the losses.
For example, if I have a net capital loss of $30,000,
and no capital gains, it would take me 10 years to fully deduct that loss
($3,000 x 10 = $30,000). In this situation, I should use those losses to my
advantage and take as many capital gains as possible, up to the $30,000 limit.
Those profits would essentially be tax-free (except, of course that you paid
taxes on those monies to begin with, if you recall.)
Municipal bonds
Having a maximum marginal tax rate of 20% on net
long-term capital gains is good; having a rate of zero is even better. Any
interest earned on municipal bonds -- bonds issued by the state or any
subdivision of the state -- is not taxable for federal income tax purposes.
(Some special purpose municipals may be subject to the alternative minimum tax
but that discussion is beyond the scope of this article.) Because these are
tax-free bonds, they usually pay a lower rate of interest than taxable bonds.
In comparing returns, you should always compare the
after-tax returns. Whichever investment offers the higher return should be your
first choice, in most cases. Don’t forget to consider the impact of state
taxation in computing final yield. For example, most states do not tax interest
on municipal bonds issued within their own borders but may tax the interest on
bonds issued by other states. Check the rules for your state at right.
Savings bonds
To help finance qualified higher education expenses,
Congress created a new incentive to purchase U.S. Savings Bonds. Under current
law, interest that accrues on savings bonds does not have to be reported until
the bonds are redeemed, unless you decide to report the increase in redemption
value each year. For years after 1989, you can potentially exclude all or a
portion of the interest that accrues on the bonds. The steps necessary to
qualify for the exclusion are listed at right.
If your adjusted gross income in the year of
redemption exceeds $79,650 on a joint return or $53,100 on all other returns,
there is a phase-out of the benefit. This phase-out eliminates all of the
benefits for families with adjusted gross incomes of $109,650 or more, or
$68,000 on others.
A qualified U.S. Savings Bond is any bond issued after
1989 at a discount to an individual who has attained age 24. Note that you, as
the older generation, must buy the bond. If you put the bond in the name of the
child, you lose the exemption. Remember the government bases the tax rate on the
income you’re making at the time you redeem the bond, not your income now. If
you expect to be making substantially more when you redeem the bond, that higher
income might disqualify you.
Social Security
If you receive Social Security, be aware that part of
your payments may be taxable, depending on your income. In determining how much
of your Social Security will be taxed, the Internal Revenue Service considers
not only your taxable income, but your tax-free income as well. By increasing
your tax-free income, you may be subjecting more of your Social Security income
to taxation.
One way to potentially avoid or reduce this problem is
to switch from tax-free income to tax-deferred income. With a tax-deferred
annuity, you ‘re not taxed on the income earned. That happens once you take
the distribution from the annuity. The deferred income earned by the
tax-deferred annuity does not count toward the determination of the amount of
Social Security that will be taxed. Therefore, if you do not currently need the
cash flow from the investment, a tax-deferred annuity should be considered as a
way to potentially reduce your taxes on your Social Security receipts.
investors_mini_tax.htm
