Investor Tax Issues

Tax Information and Tips for Investors

The IRS allows you to designate specific brokerage accounts for trading or investing. You can have both - if you qualify. Which you choose for your trading/investing activity could have a big impact on taxes. Taxes are another cost just like education, books, hardware, software and commissions. Spend some time consulting with a tax professional to make sure that you are doing what is appropriate for your situation. The choices you make could have a significant effect to the bottom line. We provide a brief summary of tax issues below.

Investment Activities - Capital Gains Tax

Most investment accounts will have a combination of short-term capital gains and long-term capital gains. Income is taxed as either ordinary income or at the capital gains rate. Capital Gains (unearned income) occur once an asset is sold and is equal to the profit/loss from the sale of capital assets, which includes stocks, as well as bonds and real estate. Capital gains/losses are determined by taking the difference between your cost basis (purchase price plus commission) and the amount realized from sale (sale price less commission). If the amount realized from the sale is greater than your basis, you have a capital gain.

There are two types of capital gain/loss designations. One is for short-term and one for long-term. Short-term capital gains/losses are for assets held for less than one year and are taxed at your regular marginal rate. Long-term capital gains are for assets held for more than one year (one year and one day). Most Americans will pay 15% tax, some in lower tax brackets will pay 0%, and those in the upper brackets will pay 20%.

Capital Losses are normally offset by capital gains. You can deduct capital losses against other income up to a limit of $3,000 a year, with any excess carried over to the following year(s). Dividends and interest are considered ordinary income. You have some control over the timing of a sale that can affect your rate. For example, an investment asset can be sold in January, instead of December, to move the gain to the following year for tax purposes.

Trading Activities

We highly recommend that you spend some time becoming familiar with the tax ramifications for traders. Few new traders do and end up paying for it. Your achievements as a trader depends on the bottom line – what you end up with after taxes. Tax planning should be a key component in any trading plan.

As a trader, most, if not all, of your activity is going to be short-term and therefore subject to short-term capital gains/losses. However, if you qualify, the IRS will allow you to designate yourself as a trader. A proper trader designation could allow you to itemize deductions, and deduct losses. Your CPA or Tax Advisor should be able to give you guidance on these tax ramifications.

Wash Sale Rule

A “wash sale” is when you sell a stock at a loss and then buy back substantially the same security within 30 calendar days. If the sale is determined to be a wash sale, the IRS would not consider the loss from the first sale a capital loss. The disallowed loss would be added to the cost basis of the stock and you would therefore pay higher taxes. Traders are much more likely than investors to trigger a wash sale given their activity level. Consult with your CPA or a tax advisor to choose a proper trader designation and/or legal structure.

Investors - don’t get caught unaware. Pay attention to when a wash sale might be triggered. You may end up making a different decision after analyzing your revised cost.