Hold On For a Year

Capital gain income is generally divided into two categories, based on how long you held the asset for sale. These two categories are short-term and long-term. Long-term is when the asset is held for longer than one year, short term is less than one year. The tax rates for long term are given special limits, while short term gains are taxed at the same rate wages and interest income is tax at. For example, if your ordinary rate is 25%, your long-term capital gain rate is 15%. If your short term ordinary rate is 15%, your long term capital gain rate is 5%. So on a $1,000 of gain income, holding it for less than one year could cost $250 in taxes, while holding it for one year or more could cost $150 in taxes. So if you can time the sale of the asset so that you held it for one year or more, than you could reduce your tax by as much as a third. This is for individuals, partners, and members. Corporations have no difference in tax rates.

Pair Up Your Losses

If you have some other investments that you lost money on, sell those losses off in the same year that you sell the winning investment. Capital gains are reduced by capital losses. Capital losses provide a very limited tax benefit by themselves, but can be accumulated over years and used to reduce or eliminate taxes on capital gains. You have to look at your previous tax returns to see if you have any capital losses from last year that you can use this year. If you have current stock investments that are in losing positions, remember that you have to sell them and not buy them back for over 60 days to claim the loss.

Exchange the Gain

If the investment you’re holding is like-kind property, such as real estate interests, a vehicle, or other similar property; you can do a like-kind exchange. A like-kind exchange is when you sell the winning investment, and invest the proceeds into another investment that is “like-kind”. This is used all the time in real estate (that you don’t live in) and other properties. You effectively defer recognizing the gain, and bury it into the next like-kind investment. This won’t work for stocks, bonds, futures contracts, partnership interests, or membership interests, or for real estate that you lived in as a primary residence.

No Place Like Home

If your investment is your home, you can exclude some or all of the capital gain income if you lived in the home for 2 out of the last 5 years. Called the Section 121 exclusion, $250,000 (or $500,000 if married) of capital gain can be excluded because it was your primary residence. You generally cannot have used this exclusion in the last 5 years in order to use it, and there are some ways to get a partial benefit if you lived there for less than the full 2 years.

This is a general discussion of general tax law to general situations. Your specific circumstances may be different. Accordingly, nothing in this blog is intended, or can be used, to avoid penalties that may be assessed under the Internal Revenue Code or other Income Tax authority. Always get assistance from a tax professional about your specific tax situation.

“What happens to my tax return when I get married?” This is a question I get from time to time, generally from the newly engaged. Quite a bit, actually. Filing status, marriage penalty, adjustments to thresholds, even health insurance plans. When two people become one, more than the last name on the driver’s license changes. Here is what you need to know to avoid getting an unhappy surprise at tax time.

Did Someone Change Their Name

After the wedding, you generally have to file with the courthouse to legally change your last name to your married name. This allows you to get a new driver’s license, change the names on your bank accounts, and report the new name to the credit agencies. However, what many people forget is to change their name at the social security office, and have a new social security card issued.

What happens if you don’t? When you file tax returns electronically, your last name is compared to a list the IRS receives from the Social Security Administration around November. If you didn’t change your name with Social Security, or changed it after they sent the IRS the list, the IRS will still look for your maiden name when comparing social security numbers. If you electronically file with your married name, the tax return will be automatically rejected. This leaves you with two options. You can mail the tax return to the IRS with your married name, which takes longer if you expect a refund. Or, you can electronically file with your maiden name, which may make it difficult to cash a refund check or receive a direct deposit refund if you have already converted your bank accounts to your married name.

Are You Still Single?

After your name and address, the IRS wants to know if you are married, and if you file a joint return or separate. For purposes of federal taxation, you are married for the entire year if you are still married on the last day of the year. In essence, your marriage is effective retroactively to the first day of the year you actually got married.  You are no longer allowed to file as a single, even though you may have been single for eleven months of the year.

The decision to file a joint or separate tax return can be simple. In most cases, your tax situation is better when the return is filed jointly. However, in a non-community state, where one spouse earns significantly more than the other, sometime a separate filed return can save you money. Talk with a tax planner if this situation sounds like you, and remember this won’t work in community property states, such as California. Other reasons to file a separate return generally have to do with protecting the liability of one spouse from the business or tax problems of the other spouse, and for divorce planning.

What Marriage Penalty?

If both spouses work, which is often the case for newlyweds, you will be taxed more than when you were both single. This difference is frequently called the marriage penalty. It comes from different places in the tax code, but the most commonly referenced location is the tax tables. The United States has a progressive tax system, such that as income levels increase, the rate of tax also increases. The penalty comes in that the income level before a tax rate change for two single people is not the same as for a married couple.

For example: in 2000 a single person switched from the 15% tax rate to the 28% tax rate when taxable income rose over $26,250. Thus if two single people each earned $26,250, a total of $52,500, their top tax rate would be 15%. But if they married, they would leave the the 15% tax rate and jump to the 28% tax rate when taxable income rose over $43,850, a difference of $8,650. This difference would be taxed at 28% instead of 15%, approximately an additional $1,124 of income tax. This additional $1,124 of tax is considered the marriage penalty, because two people single in the same circumstances would not pay this additional tax.

Fortunately, this marriage penalty went largely away in the early part of this decade under what are generally called the “Bush Tax Cuts” after the US President that enacted them. But these tax cuts are due to expire this year. As I write this, Congress will be entering the “lame-duck session” after the election to consider renewing the Bush Tax Cuts, or some provisions of them. So it is possible this will come back. And for income earners well north of $150,000 per year, the marriage penalty is coming back very strongly, with tax thresholds at $200,000 for singles and $250,000 for married.

High Deductible Happiness

While not every benefit and deduction provision of the tax code doubles when two people become one, some actually grow. During 2010, Health Savings Accounts allow individuals with high-deductible health insurance plans to contribute about $3,050 per year to a special account and get a tax deduction. (the actual contribution limit varies depending on how long you had coverage and is adjusted each year for inflation)  Then the money in the account can grow year over year, or be used for any valid medical purpose, without ever paying taxes on the money. What happens however, is that after getting married, the happy couple convert their insurance from two self-coverage plans to one family coverage plan. The contribution limit for a family plan is $6,150 (also subject to adjustment), $50 more than what two single people would be permitted to contribute.

As always, this is a general article about a general tax situation, and it may or may not apply to your individual tax situation. Accordingly, nothing contained here is intended or can be used to avoid penalties that may be assessed under the Internal Revenue Code. Always consult with your personal tax adviser.

Sponsor a Charity Event

As the year draws to a close, every public charity would like to remind you to give a donation before year-end to pick up a tax deduction. But a better way to give is to sponsor an event. By offering to be a sponsor you not only put your business name on the programs and banners of the events, you also convert a charitable deduction (subject to limits) into a promotional expense, a business expense that is unlimited and reduces self-employment taxes.

For your Health

Pay your health insurance premiums before year-end. If you have self-employment net income this year, you get to take your health insurance premiums as an adjustment to income, instead of a medical expense.

If you have a high-deductible health plan, get a Health Savings Account. These are the accounts where you get a tax deduction to put money in, and the money can accumulate in the plan, year after year. Get the money to pay for qualified medical expenses, and you never have to pay income taxes on the money or its earnings. You can contribute up to $3,050 as an individual and $6,150 as a family.

Get Ready for Higher Capital Gains

The capital gains tax rate for 2010 is 15%, but the rate for 2011 is expected to be 20%. To take advantage of the best capital gains tax rate you will have for years to come, it will be cheaper to take profits this year than next year. Talk with your investment advisor about selling your ‘in the money’ stocks, even if you choose to rebuy them right away.

Because of the higher taxes, this is also the year to get any remaining skeleton’s out of the closet. Any decisions you were waiting on for tax rates to drop, this is the time. This includes a Roth Conversion on any retirement assets you have (don’t break the payment into two years though).

Fix Up Your Mileage Logs

The deduction for mileage is 50 cents per mile for 2010, and is fully deductible IF you have a mileage log. The act of putting together a mileage log is well worth the benefits, as many taxpayers don’t take the deduction they could.

Energy Credit for Home

30% of the costs of energy-efficient improvements installed in 2010 are credited against your tax, up to $1,500. 30% of the cost of solar panels, solar water heaters also serve as an unlimited credit against tax.