It’s been over a year since my last Monthly Review and I believe it’s time to bring them back. While other bloggers have continued their monthly income statements and balance sheets, I stopped a year ago because I felt it had become counter-productive. The reality is that the numbers themselves are irrelevant because they don’t apply to anyone else and they don’t help people make better decisions or learn from my mistakes. In fact, I felt that the numbers may be a distraction from the ultimate purpose of my monthly reviews, which was the explain both the good choices I’ve made as well as the bad choices.

So, in this return of monthly reviews, I’m going to simply outline the good, the bad, and the ugly of the decisions thus far. From here we’ll see how the month to months go.

Good

• Marriage: Since my wife and I got married this year, our tax situation for 2007 was unchanged. We are, fortunately or unfortunately depending on your perspective, are one of the many couples affected by the “marriage penalty” created by uneven tax brackets (married filing jointly brackets are not double the single brackets). Additionally, since the house and mortgage are both in my name, I was itemizing while she was claiming the standard deduction. Next year, we will be hit with the marriage penalty plus the loss of a standard deduction… considering its something we didn’t have much of a choice about it (hush those anti-marriage folks in the crowd!) we’ll just roll with it.
• Going with Accounting Pro: I’m now working with an accountant to handle some of my business taxes and help me become legit with the online enterprises. There comes a time when you just have to pay a professional and it’s now time for me to pay (rather than to be the professional/consultant!). It’s not cheap but it forces a rigor that is far superior than the record-keeping I had been doing before.

Bad

• Capital Gains: I made a mistake last year in selling some funds for capital gains but then not offsetting them with some capital losses that we should’ve taken, that was a big mistake. We took on about $5,000 in short term capital gains without offsetting it, whoops. That was entirely my fault.
• Stupid Fees: In all the marriage madness and my own ignorance, we took five months of $3 fees for having less than $300 in our savings account at Bank of America, despite having more than enough in our checking account. Dumb dumb dumb. We got $15 back, for three months, but they said they couldn’t go back farther. I was going to push for the other $6 but they wouldn’t budge and, honestly, I don’t blame them. One month I can understand, five? Hmmm… I screwed up.

Ugly

• Stock Market Suckage: This is ugly not because we made any bad decisions but only because it’s happened. In our taxable brokerage account, we’ve had about an 11% in loss on the holdings stretching back into Q4 of last year. That’s pretty gnarly, but nothing we can do, and we’re just going to set it in forget it.
• Honeymoon: Honeymoon is expensive and one of my vices is splurging on vacations. You only get married once right?

The Future

• Rolling Over 401(k)s: We need to investigate the rolling over of all of our legacy 401(k)s to our Vanguard, each of us has one legacy 401(k) to move. It’s not a difficult process, we just need to hammer out the specifics of doing the trustee-to-trustee rollover process for each account. Don’t want to take a disbursement… that’d be ugly (and foolish).
• Consolidating Accounts: We also need to start consolidating all those excess accounts so we can simplify our finances. The process is made much more difficult as my wife is changing her name so we’ll have to wait for those to shake out before we can finalize all of these. I personally have too many accounts to keep track of so it would be good to start cleaning these up.

I hope this satisfies the voyeurs out there, at least for now, but look for more updates starting in May.

I heard this “tip” the other day involving how you could take advantage of the market downturn. Each year, you’re permitted to give up to $12,000 to someone else as a gift absolutely tax free. If you give more than $12,000 to one person, you’re personally obligated to declare it and pay taxes on the gift (yep, it’s in reverse of what you’d expect). So, the suggestion is then to give your depreciated shares as a gift now, before the shares are likely to rebound, so that you can make the most of your gift.

Sound like a crazy idea? (It sounds crazy to me) It’s not so crazy if you subscribe to the idea that the stock market will always appreciate in the long run (if you don’t, then you better not have any shares of anything!), but it’s certainly one way to find a silver lining in this ugly stock market cloud we’ve been under!

The Mechanics

If you are actually going to do this, this is how you do it right. These steps are different than if you gift appreciated property (stock is considered property), so please follow them carefully. You will need to do the following to properly document the gifting of your shares:

1. Obviously, give the shares to your beneficiary.
2. Document the fair market value of the shares by writing a gift letter that indicates the gift and its fair market value at the time of the gifting.

Appreciated vs. Depreciated

The is a big difference between donating appreciated stock and depreciated stock. If the stock has appreciated, the recipient has to claim the appreciation when it is sold. People often take advantage of this by gifting appreciated stock to their children, or family members in a lower tax bracket. With depreciated stock, no one gets to claim the loss. So, it might make more immediate sense to sell the stock, recognize the loss, then give the money to your beneficiary and then have them buy the shares back.

To be honest, I wouldn’t do it. I like crazy, out of the box thinking as much as the next person, but this one doesn’t seem to make much sense to me. It makes more sense to claim the loss against any gains that year, then give the money. The recipient can always buy the shares on the open market and pay the commission.

(Photo by rednuht)

The blogosphere is chock full of things you should do at the end of the year, like making donations and saving kittens, but what about those things you shouldn’t be doing? I’ve put my brain on the subject and while I’m not a tax expert, I believe the following list is a good start of things to avoid doing near the end of the year if you want to save yourself a few tax dollars.

1. Don’t Get Married:

The marriage penalty pretty much sucks (but marriage is awesome!) and your filing status for the year is based on your filing status when the year ends, December 31st. It doesn’t matter if you get married 11:59pm on December 31st or 12:01am on January 1st, your filing status is married no matter what. Is the marriage penalty really that bad? Two singles making $70k a year will pay a total of $13,923.75 each in taxes, or $27,847.5 combined. A married couple making $140k a year combined will pay $28,192.50 - $345 more. I don’t know about you but I’d rather put that $345 into my pocket than Uncle Sam’s.

2. Prepaying Taxes & Other Unallowable Deductions under AMT

The Alternative Minimum Tax is an ugly word lots of people have been throwing around lately and it has the potential of taking a positive tax move and turning it into a hugely negative one. Prepaying certain deductible expenses, such as state/local/property taxes, early allows you to take the deduction earlier - that’s a positive tax move. However, if you are subject to the AMT, you aren’t allowed to take those deductions so you face the double whammy of prepaying your taxes (you lose interest on the money in a bank account) plus you get no benefit for doing so (tax deduction).

First determine if you’re subject to AMT (there is no 2007 calculator, I would just use the 2006). If you are, don’t prepay these normally deductible expenses (state and local income taxes and property taxes, un-reimbursed business expenses, child-tax credits, tax-preparation fees, legal fees, home-equity loan interest). If you are, then try to prepay them if you can so they can be applied to your 2007 tax bill, instead of your 2008 tax bill.

3. Don’t Sell Stock - Lower Capital Gains Rates in 2008

If you’re in the 10% or 15% income tax bracket, next year that your long term capital gains tax will fall to 0%, so wait a few more weeks if you’ve been thinking of pulling the plug on an investment.

4. Defer Compensation If You Can

The following moves all fall under the greater heading of deferring compensation because money you earn in December 2007 is taxed on April 2008. Money earned in January 2008 is taxed in April 2009 - a significant difference for such a short delay.

• 4a. Don’t Take That Bonus (Yet): Bonuses are hot but try to push the payment of that year end bonus to the new year and you can push the tax bill to next year also.
• 4b. Don’t Take A Capital Gain (Yet): Much like a bonus, don’t take a capital gain near the end of the year when you can push it to next year. The reasoning is the same - you get your cash in a few weeks and you get the tax bill in over twelve months. If you have a loss this year, you can even use that to reduce your income. (plus, you might be seeing lower tax rates)

This is part of a Money Blog Network group project in which we discuss some great year end money moves, I went against the grain with this one. If you can think of any moves one should avoid at the end of the year or have any thoughts on any of these, please do share them and I’ll add it to the post.

Starting next year, until 2010, if you are in the 10% or 15% marginal income tax bracket, your tax on long term gains falls from 5% to 0%. Everyone else, that is the 25% to 35% tax brackets, still pays the same 15% capital gains rate. In 2011, everything reverts back to how they were before 2003, that is 10% for the 10%/15% brackets and 20% for the 25%-35% brackets. Think of it as four year long (because you can start the long term clock now) Roth IRA if you qualify. Team this up with $4.95 trades at TradeKing and you’ll practically have no expenses whatsoever.

Unfortunately if you’re single and in the 10% to 15% brackets, your income is under $31,850 (2007, it’ll be higher in subsequent years), of which you pay approximately $5,560 each year in taxes (if you made $31,850 on the dot), so with a take home pay of at most $26,290 and the cost of living in most areas, you’re probably not thinking of investing much anyway… but every bit helps!

Source: USA Today

I forget what show I was watching, but it was one of those shows where you have all that Bloomberg ticker crap taking up 75% of the screen and little faces jibber jabbering in the leftover space, but the guy talked briefly about how your IRS 1040 (the full incarnation of the form everyone fills out for taxes) gives you subtle reminders of the things you should do to help plan your financial future. I didn’t watch the whole thing but I thought it’d be fun to go through each relevant line (yeah, I’m a sadist) and see how it could be used as a subtle yearly financial plan reminder.

Line 8a - Taxable Interest
Line 8b - Tax-exempt Interest
There are investment vehicles out there that are tax exempt at certain government levels. For example, an EE/E bond is exempt from State and local income taxes but not from federal taxes. This is a reminder that sometimes your most conservative assets may be better placed in a tax-exempt bond than in a savings account bearing 3.0%. Of course, you sacrifice flexibility but you should know tax-exempt investments are out there but you do keep Uncle Sam’s grubby little paws off your loot.

Line 13 - Capital gain or (loss)
This is something you can only capitalize on if you remember it before December 31st. If you have a loss and want to write it off, sell it to offset a gain you may have had. Just remember not to repurchase shares in the same company within 31 days or the “wash” rule will bite you (and you won’t be able to write off the loss). Did you buy shares of JDS Uniphase and got burned badly in the bubble? Yeah, me too, write it off now because they’re never going to break even for you.

Line 15a - IRA distributions
Line 25 - IRA deduction
Contribute to a Roth or any other type of IRA? These lines are a reminder that perhaps you should be planning for your retirement because Social Security won’t be enough to sustain a lavish retirement lifestyle! Retirement planning, especially for young workers, is critical because it is something that benefits with the passage of time. The more you sow now, the greater the benefits you will reap in the future. You want to be living in luxury when you’re retired, not a cardboard box. (You cannot deduct Roth contributions on your return, I just intended for that line to serve as a reminder to plan for retirement)

Line 33 - Penalty on early withdrawal of savings
Tsk tsk! That IRA or 401k isn’t a slush fund you can withdraw on to buy that shiny [whatever]. Let line 33 be a reminder that you will be penalized for mortgaging a portion of your retirement for gratification now. Alright, I’m just kidding about the severity but you should be readily dipping into your retirement for every thing. Sometimes it makes financial sense, but most (90%) of the time it’s a bad idea. (Example of good ideas? In times of hardship, dipping into the retirement savings may be unavoidable)

Line 49 - Education credits
The government will help you educate yourself, even if your employer will not. Learn about Hope Credit and Lifetime Learning Credits and see how you or your dependents may benefit from them.

Unless I’ve missed anything glaring, those 5 “lines” cover a lot of the basic financial planning advice given out these days. Consider all investment opportunities with respect to the tax advantages, plan for your future, don’t mess up your future by needlessly borrowing from it, and always educate yourself. I’m not saying that the dreaded tax form should be your financial advisor, a human being almost always beats a piece of paper, but it gives you a couple subtle reminders for things you may have forgotten or conveniently ignored. Take a look at your return and see if you’ve taken advantage of everything you could’ve.

This is the third post a series of Tax Relief advice articles, be sure to read the first one about Deducting State Sales Tax Instead of State Income Tax and the second one about the Alternative Minimum Tax. You can see the whole collection under the category of Tax Relief 101.

If you invest in anything whatsoever, capital gains and losses are a necessary and often misunderstood aspect of your taxes. What differentiates a long term capital gain and a short term capital gain? If I miss on an investment, how can that pain be lessened by gains you’ve had in other investments? What’s this I’ve heard about dividends being taxed at a lower rate? Get your pens and pencils and read on.

Long Term vs. Short Term Gains
If you’ve owned the investment for over 366 days (1 year plus 1 day), then it is taxed as a long term capital gain. If you’ve owned it for less than a year, it’s taxed as a short term capital gain. It’s as simple as that.

Recently, the long term capital gains tax rate was lowered by 5% for every tax bracket (effective until 2008) . Now, the rates are 5, 15, 25, and 28%. If your income is taxed in the 10-15%, your maximum long term capital gain tax is 5%. Everyone else is taxed at the 15%. The 25% rate applies to real estate you’ve sold that you claimed any depreciation on (Section 1250 property). The final 28% category is for small business stock and collectibles.

Short term capital gains? They’re taxed as income for the year! If you’re in the 15% tax bracket, it’ll be taxed at 15% (instead of at 5%). That’s why they say that short term capital gains can eat into your stock profits because of the significantly higher (10% difference) tax rate.

Capital Losses Offsetting Capital Gains
If you make a bad pick (or two or twenty), any losses you sustain can be used to offset any gains you had this year. If you had a particularly bad year and had no gains, up to $3,000 of the losses can be used to offset your other income. If you’ve lost more than $3,000, then you can carry it to the following year. That’s why you hear advice from professionals about selling stocks in which you’re in the red in order to offset the gains you’ve had. One important rule you must understand is the “Wash Rule” which only allows this offset if you do not repurchase the stock within 30 days, otherwise this is thrown out.

Dividends Taxed at 5, 15%
Remember the two tax brackets for gains? Well now dividends are taxed at those rates, 5% for 10-15% taxpayers and 15% for everyone else.

I hope I’ve covered a few of the big concepts of capital gains taxes that give people the most trouble and dispelled some of the misconceptions people carry around. I wouldn’t let capital gains taxes dictate your investment strategy but it’s a very important aspect to always keep in mind.