Friday, November 19, 2010

Year End Tax Planning

Thanksgiving is coming on Thursday and Christmas is not far behind. We are nearing year end and it is probably a good idea to get our ducks in order as far as our trading goes. Before I continue I want to caution all that the remainder of this article just contains some general thoughts about planning and tax issues and is definitely not to be taken as advice. Tax planning advice should be obtained from professional advisors like CPA's and attorneys who practice in the field.

In any event, it is a good time to take stock of where your trading positions or investments stand. Do you have losers in the portfolio and, if so, have you taken gains during the year that you might want to offset for tax purposes by selling the losers. Remember the tax code distinguishes between short term and long term gains and losses. Again, seek professional advice and don't rely on this article to make your decisions. It is my understanding that short term losses can be set off against short or long term capital gains but not against "income." Short term gains are taxed at regular rates. Long term gains, on the other hand are taxed at the currently lower capital gains rates and certain long term losses may be set off against those gains; even losses from past years if they have been carried forward properly.

The political debate is ongoing about whether to extend the current tax rates or some of them depending on one's income level or whether to permit them to expire. Expiration of the current rates would result in significantly increased rates on dividends and, to a lesser extent, on long term capital gains and, depending upon bracket potentially to short term gains as well. There also is a bill pending in Congress to tax all "transactions" at 1% which, if passed, could result in a 1% tax on literally every trade, both buying and selling, or for that matter, even when one makes a deposit or withdrawal from a bank account or trading account.

In short, we really can't know the tax answers until this lame duck Congress makes up its mind on expiration, extension, or extension for favored income groups. Nevertheless, we should be mindful that the rules or rates may well change regarding capital gains, dividends, and, potentially, on individual transactions. While I suspect it is unlikely that the transaction tax will become law, if passed, it could definitely affect trading for me and would almost certainly cause me to drastically reduce the number of overall trades I might make. So, too, if dividends return to being taxed at regular income rates some of us may rethink strategies related to how we trade dividend yielding equities or whether our emphasis in the selection of investments might change. For example, we may find that municipal bonds may have more appeal than dividend paying stocks if production of after tax income is a major part of our plan as opposed, for example, to capital gain production.

All of this is meant both as a suggestion to review where you are from a current tax perspective so that you and your tax professional can best prepare for year end and as a call to awareness of where you might be headed in terms of your future plan and strategies depending upon the political outcome of the current tax debate.

Happy Thanksgiving everyone!

by Bill Kraft, Editor
Copyright 2010, Makin' Hay, Inc.
All Rights Reserved

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John Watson said...

Thank you Bill for all your insights in these articles. I read them religiously every week and have done so for years. I just want to point out that I think one of your statements in this week's article is incorrect. You said "It is my understanding that short term losses can be set off against short or long term capital gains but not against "income."" Short term losses up to $3000 exceeding any capital gains can be offset against income at least for 2009. Did the law change for 2010?

Bill Kraft, said...

Thanks for pointing that out John. I do not know that the law changed in 2010 and you are quite probably correct. As I mentioned in the article, it is important to seek tax advice from a tax professional and definitely not rely on me for tax advice. I only wanted to point out that these issues, in general, might well be investigated before year end.
Bill Kraft