9 Year End Tax Moves to Make by Dec. 31st

1040 Bobblehead DudeAfter last week’s Thursday post on adjusting your tax withholding, I thought that we needed a full blown post on the best year end tax moves. So who better to turn to than prolific tax expert Kay Bell, author of The Truth About Paying Fewer Taxes? She was kind enough to list not one, not two, but nine tax moves you can make before the ball drops.

It’s time to make your year-end tax list and check it twice to ensure that you give yourself the gift of tax-savings. Here are 9 ways this month to help make your 2009 tax bill as small as possible.

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Ten Easy Year-End Tax Tips

Year-End Tax TipsHave you thought about your taxes lately? Probably not, but this month is probably one of the most important months in tax planning because it’s the last time you’ll have an opportunity to effect any meaningful change to your taxes next year. Once December ends, 2008 is essentially frozen and your taxes will be what your taxes will be. So, what sorts of tax moves should you consider making?

Sell your stock losers. Any losses you realize from the stock market, that aren’t offset by gains, can be deducted from your regular income, up to a limit of $3,000 a year. If you’ve been thinking about dumping some losers, now’s the time to do it. If you have more than $3,000 in losses, you can carry those forward indefinitely (until death). More advanced traders may also consider tax loss harvesting as an option as well.

Donate to your favorite charities. Times may be tough but they’re even tougher for charities and philanthropies, who rely on generous contributions to stay in operation. Consider donating money, goods, clothes, your car, anything – to one of your favorite charities so that they can stay operating through these difficult economic times. If you itemize your deductions, you can deduct contributions from your regular income.

Delay bonuses and income. If you can swing it, try to push any additional payments until the new year. If you are paid this year, you have to pay taxes on it in a few months. If you are paid next year, you won’t have to pay taxes on it for an extra year. If your employer withholds taxes on your bonus payments, this is a less valuable strategy. 🙂

Prepay state and local taxes. This one is a little tricky, if you don’t think you’ll be subject to the AMT, consider prepaying your state and local taxes. State and local taxes are federal tax deductions so prepaying them today means you can deduct them today as well.

Accelerate other deductible expenses. If you have a mortgage, consider paying next month’s payment this month. If you pay it this month, you can deduct the interest payment against this year’s income. If you pay for it on January 1st, it’ll have to wait until you file 2009 taxes. This is true of any deductible expenses you may have from student loan debt to medical to your real estate taxes. If you want, you can make the payment with a credit card and then pay off the credit card next month and still have it be deductible for 2008.

Use up your $12,000 gift exclusion. Each year, you are allowed to give $12,000 to someone else tax-free. If you give more than $12,000, then you are subject to what is known as the gift tax. It’s a little backward but it’s a page out of the estate planning book since heirs to an estate are often taxed on that estate. Anyway, if you were planning on giving someone a very generous gift, don’t forget to to do it. Next year the limit rises to $13,000 so you can give $25,000 to someone within a week and avoid the gift tax ($12,000 on December 31st, $13,000 on January 1st). If you are married, you could give someone $50,000 ($25,000 from each spouse).

Beware buying into mutual funds with capital gains distributions. Mutual funds buy and sell stuff all year, then distribute a bit of that at the end of the year. What you won’t want to do is buy into a mutual fund that is set to make a year-end capital gains distribution because you’ll be immediately taxed on that distribution. Imagine a mutual fund that costs $100 a share. You buy it and the next day it makes a $1 per share distribution, lowering the cost per share to $99. You just bought the thing and already are on the hook for $1 per share in taxes. Boo!

Contribute to your retirement. If you aren’t maxed out on your 401(k), or similar, plan, consider doing it because each dollar contributed is entirely deductible. The 2008 contribution limit for your 401(k) is $15,500 ($20,500 if you’re 50 or greater). Another good idea is to contribute towards your IRAs but you have until April 15th to accomplish that.

Get married. Your tax filing status is based on your status as of December 31st, 11:59 PM. If you were married on December 31st, you’re considered married for the year. If that helps your tax situation, you might want to consider it. 🙂

Get everything ready. If you’re due a refund, try to get all your ducks in a row as soon as possible so the government will mail you your refund check ASAP. All you’re really waiting for is the official W-2 from your employer, which they are required to mail out by January 31st, and you should be ready to hit the e-file button.

(Photo: thetruthabout)


Tax Loss Harvesting

Tax Loss HarvestingHas the stock market decimated your portfolio too? Yeah, us too. Fortunately, there’s something called tax loss harvesting and it can help anyone get a little edge on the recovery. The idea behind tax loss harvesting is that you sell a particular holding, take the capital loss, and then immediately invest it in something similar but not the same as the original holding. By doing this, you “harvest” some of your losses to offset gains or ordinary income, and by investing in a similar but not a “substantially identical security,” you also benefit from the recovery. The key in this strategy is that you invest the tax savings, from the loss, back with the original sum.

Some words of advice on tax loss harvesting:

  • The reason why you can’t by something “substantially identical” has to do with the wash sale rule. If you want to deduct the loss, you have to follow wash sale rules.
  • Don’t do this in a retirement account. There is no capital gains or losses tax in retirement accounts. 401(k)’s and IRAs appreciate without taxes and taxes are only assessed at distribution time (with the exception of Roth IRAs, which are never taxed).
  • Substantially identical is a gray area because the IRS hasn’t clearly defined it but make sure it passes the sniff test. One interesting thing of note is this explanation on IRS Publication 564: “Substantially identical. In determining whether the shares are substantially identical, you must consider all the facts and circumstances. Ordinarily, shares issued by one mutual fund are not considered to be substantially identical to shares issued by another mutual fund.” The key word there is ordinarily. Just pass the sniff test, I’m sure your nose works well. 🙂
  • If your capital losses exceed your gains, you can deduct $3,000 of capital losses against your ordinary income. If your losses exceed that, you can carry those losses forward each year without limit.
  • You don’t have to wait until the end of the year to do this, in fact it’s probably better to give yourself the flexibility of doing this earlier in the year because of wash sale rules.

Why Tax Loss Harvesting Works

Let’s consider the scenario where a fund has dropped 10%, the investor opts to harvest losses and immediately invests in a fund that closely mimics the original fund. Both the original fund and the new fund appreciate by 11.1%. The investor invested $10,000 and is in the 25% tax bracket. Who wins?

Does not tax loss harvest: This scenario is simple, the investor has effectively had no change because the original fund has return to its original value. He sells and has no capital gains or losses.
Does tax loss harvest: The fund fell in value from $10,000 to $9,000 and the investor does some tax loss harvesting to extract the $1,000 in loss. The $1,000, come tax time, will yield him $250 in tax savings. He reinvests the $9,250 into a similar but not “substantially similar” fund and it appreciates by 11.1% to $10,276.75. When he sells, he pays taxes on $1026.75 of capital gains – or $256.69. Subtract that from his $10,276.75 and he’s left with $10,020.06, which is $20.06 ahead of what he had if he hadn’t harvested losses.

Tax Loss Harvesting with Placeholders

Let’s say that you really like a particular mutual fund, your brokerage doesn’t offer anything similar, and you aren’t about to open up another account at another brokerage just to do this tax loss harvest. A potential option is to use exchange traded funds (ETFs) as a placeholder for the wash rule period. Sell your loss, buy into an ETF, wait 31 days, then sell the ETF and get back into your fund. By selecting a similar ETF, you can catch any rises in the industry without sitting on the sidelines.

Please consult with an accountant to clarify your particular situation before doing anything I’ve talked about here.

(Photo: tonivc)

 Monthly Review 

Return of Monthly Reviews!

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.

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Gift Your Depreciated Stock Shares

Stock Market All RedI 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: rednuht)


Dumb Year End Money Moves: Marriage, AMT, Bonuses & More

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.

 Investing, Taxes 

0% Long Term Capital Gains Tax!

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


Introduction to Pre-IPO Stock Options

I’m not an investing guru, I dispense no professional advice, and the only investing training I have is from the University of Google where classes are available 24/7. That being said, I recently had a chat with my girlfriend who was being compensated, in addition to salary, in the form of pre-IPO shares in the company she’s currently working for. Having little to no understanding of the terminology of options, let along pre-IPO stock options, I had to seek an education.

Here’s how it works, you get hired and they give you a option grant – a document that says how many shares you can buy and for how much. The strike price is the price at which you can purchase the shares. The grant date is the date you officially begin vesting and should be on that option grant sheet.

Capital Gains

You have two dates to remember, the grant date and the exercise date. The exercise date is the date you purchase the shares from your option.

If you sell your shares within two years of your grant date or one year of your exercise date, it is called a disqualifying disposition and your earnings will be treated as income. If you sell within one year of your exercise date, it will be considered short term capital gains – taxed at your marginal tax rate.

Lockup Expiration & Blackout Periods

A lockup is a period of time after an initial public offering when pre-IPO shares can’t be sold; check how long you’ll have to wait after the IPO before you can sell your shares. A blackout period is a period of time, usually around earnings announcements and the like, where you can’t trade your shares either. There is an SEC mandated 3 day waiting rule for trading after announcements too.

Okay, now the vocabulary lesson is over…

Evaluating How Rich You’ll Be

You are not rich. Options are worth nothing in an IPO, just ask all the dreamers from the dotcom era, but they have potential to earn something. How can you figure this out? You really can’t unless you have a crystal ball but if you just ballpark how companies in your industry are faring, how you compare to them, you might be able to ballpark a share price if you know how many shares your company plans on IPO’ing with.

Get everything in writing

This is sage advice for everything. Make sure that option grant explains everything, the schedule your shares vest, what happens in a buyout, etc. because while the intentions might be good when the company is performing well, people can get real ugly when the ish hits the fan.

Remember the old adage, “a bird in the hand is worth two in the bush.”

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