Year-End Tax Planning for Investors
If you expect to sell securities for a profit in a taxable account, consider doing so in 2009 while tax rates are at low levels. Some predict that those rates may soon move higher. What’s more, you may be able to shift your gains to loved ones who’ll owe no tax in 2009.
Example #1: John Brown has two children, ages 18 and 21. Both will be full-time college students in 2010. To pay their college bills, John expects to sell some securities. Because all the securities in his taxable account now trade at prices higher than his purchase price, John expects to generate capital gains when he sells them to raise money for college costs. John may be able to avoid some capital gains tax if he transfers appreciated securities to his children and takes advantage of the “kiddie tax.” Under the “kiddie tax” rules, full-time students under 24 are considered to be “kiddies” as long as their earned income is less than half of their support. These “kiddies” can sell appreciated assets and owe 0% tax under rules in effect in 2009.
Suppose, in this example, that John’s two children will each have $400 in interest from bank accounts this year and no other investment income. John transfers appreciated securities that he has held for more than one year to each of his children. (He should make these transfers as soon as possible so the children can sell the securities in 2009.) If each child sells securities for a $1,500 gain, each will have $1,900 of unearned income this year: $1,500 of long-term capital gains plus $400 of interest. John’s children, who qualify as “kiddies,” can sell the appreciated assets and owe 0% tax.
Thus, if your children qualify as “kiddies” and you hold appreciated securities, transfer those you’ve held for more than one year to your children for a sale this year. Such sales will qualify for the 0% rate as long as each child’s total unearned income, including any transfers, is no more than $1,900. As of this writing, the 0% tax rate for low-income taxpayers is scheduled to remain in effect for 2010. If that is still the case in January, you can repeat this maneuver then. In fact, the $1,900 kiddie tax ceiling might be slightly higher in 2010 because it increases with inflation. (In the “Green Book” published by the Treasury Department in May 2009, the Obama administration proposes to retain the 0% tax rate for low-income taxpayers.)
Other loved ones, such as your parents and children 24 and older, are not subject to the $1,900 kiddie tax limit. Single taxpayers may have taxable income up to $33,950 and owe 0% on long-term capital gains in 2009. For couples filing joint returns, the upper limit is $67,900. If you plan to sell appreciated securities, you may wish to transfer them to taxpayers who will be under those ceilings for tax-free sales in 2009.
The 15% Solution
In the preceding example, the securities that John Brown transfers to his children might not provide enough money to pay their college bills. If that’s the case, John may have to sell more appreciated securities and pay tax on long-term capital gains. John can wait until 2010, thus deferring his tax bill. However, there is no guarantee that the 15% maximum tax rate on long-term gains will remain in effect next year. Congress may respond to financial pressures on the federal government by raising that rate, perhaps limiting the increase to high-income taxpayers. For this reason, John might decide to make planned sales in 2009, locking in the tax on the gains at 2009 rates. (The Green Book proposes an increase in the tax on high-income taxpayers’ long-term capital gains from 15% now to 20% in 2011. However, Congress might legislate such an increase in 2010.)
Selling short
If some of your stocks are now worth less than you paid for them, you may want to sell them—and realize those losses—before year end. You can offset net capital losses up to $3,000 against your ordinary income on your 2009 tax return and carry forward capital losses over $3,000 to future years’ tax returns with no time limits. Piling up a “bank” of capital losses may help you if you have gains from a 2009 investment and want to take profits. If you sell securities you’ve held for one year or less, you’ll generate short-term gains, which are taxable at ordinary income rates (up to 35% in 2009). Instead, you can use your capital losses to offset the gains you generate by selling the securities held short term—and avoid tax.
Looking backward
As mentioned previously, you can deduct up to $3,000 worth of net capital losses on your tax return and carry forward excess losses to future years. Therefore, you should check your 2008 tax return to see if you’re carrying forward any unused capital losses. You’ll find that information on Schedule D of Form 1040. If you have such losses from the 2008 bear market or prior years, you can take gains to soak them up without paying any taxes out of pocket.
Example #2: Louis Ward has $20,000 worth of loss carry forwards from previous years. He hasn’t taken any capital gains or losses this year. If Louis generates $17,000 in net capital gains by the end of 2009, his loss carry forwards will offset the tax on those gains. He can deduct the remaining $3,000 of net loss against his 2009 ordinary income, reducing his existing taxable income for the year and his resulting tax obligation.
Copyright © 2009 by the American Institute of Certified Public Accountants, Inc., New York, NY 10036-8775.