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The tax tail should never wag the investing dog, but failing to consider the tax consequences of your investing activities could cost you, or at least knock some of the shine off your glowing returns. Here are some tax issues that affect every investor, and a few tips to help you keep more of your money.
And be sure to check out our other taxopedias.
What's Deductible? -- A to Z
A B C D E F G I K L M N P R S T W
Accrued interest on bond purchases. If you purchased a bond between payment dates, deduct the interest that had accrued up to the purchase date (and was included in the purchase price). If you sell a bond between interest payment dates, reduce the sales proceeds by the amount of interest that belongs to the buyer.
Amortized bond premium. If you buy a taxable bond at a market premium, you can elect to amortize the premium over the remaining term of the bond. The premium is deducted as an offset to interest income you report. This treatment does not apply to tax-exempt bonds.
Bad debts. If you loaned money to someone and have determined that you will not be repaid, you can deduct the loss as a non-business bad debt, which is treated as a short-term capital loss for tax purposes. If your business made the loan as part of its regular operations, the loss is deductible against business income.
Capital losses. Losses on sales of securities and other investments are deductible within certain limits. First, long-term losses (from the sale of assets owned more than one year) are deducted from long-term gains and short-term losses (from the sale of assets owned one year or less) are deducted from short-term gains. Net long-term losses are then deducted against net short-term gains and vice versa. If transactions result in a net loss, up to $3,000 can be deducted against other kinds of income, such as your salary. Any excess loss is carried over and used on your next year's return.
Depreciation of equipment to manage securities. If you use a home computer to track your investments, you can depreciate the investment -- use a portion of the computer's cost over a six-year period. This is a miscellaneous itemized deduction deductible to the extent that it and your other miscellaneous deductions exceed 2% of your adjusted gross income.
Employer-paid retirement advice. The value of such advice is a tax-free fringe benefit.
Foreign tax credit on dividends. If you paid foreign taxes on dividends you received, claim an income tax credit to recover the cost via lower federal taxes.
Gains on empowerment zone assets. Gains on the sale of business assets located in areas designated by the government as empowerment zones are tax free if you have owned the assets more than five years. The required holding period drops to one year for sales of business assets in designated renewal communities and enterprise communities.
Gains on small business stock. You can treat as tax-free half of your gain on the sale of qualifying small-business stock that you have owned for more than five years. The corporation issuing the stock cannot be an S corporation, and the stock must have been originally issued after August 10, 1993, by a corporation that had less than $50 million in assets. There's a long list of ineligible business, including those in the fields of health, engineering, arts, athletics, law, financial services, insurance, leasing and similar service businesses that depend on skills of a few employees. Also, corporations involved in farming, hotels and restaurants are not eligible.
Investment advice. Amounts paid for financial planning, tax or investment advice, including periodicals, investment newsletters, tax-preparation software and online services qualify as a miscellaneous itemized deduction deductible to the extent that it and your other miscellaneous deductions exceed 2% of your adjusted gross income.
Individual 401(k). This relatively new retirement plan for self-employed taxpayers often allows the highest percentage of self-employment income to be stashed in a tax sheltered account -- $15,500 ($20,500 if you were at least 50 years old at the end of 2008) plus 20% of income up to a maximum contribution of $46,000 ($51,000 for those at least age 50)-- and deducted from income. The plan must be opened by December 31, 2008, but contributions can be made until the due date of your return.
IRAs. For 2008, you and your spouse can contribute up to $5,000 to a traditional individual retirement account if you have that much earned income. Anyone 50 years old or older by the end of the year can contribute $6,000. You can fully deduct your contributions if neither you nor your spouse was an active participant in an employer plan during 2008. If one of you was a member of a plan, income limits apply. (See also: Roth IRA.) If you contribute to both a traditional IRA and a Roth, the $5,000/$6,000 contribution limit applies to the combination.
IRA custodial fees. IRA trustee or custodial fees that you pay directly out of your own pocket qualify as a miscellaneous itemized expense deductible to the extent that it and your other miscellaneous deductions exceed 2% of your adjusted gross income. If the fee is debited from your IRA, the amount cannot be deducted.
IRA loss. See loss on an IRA.
Investment interest. If you itemize, you can deduct investment interest expenses, such as margin interest paid to a broker, but only to the extent of your net investment income. Net investment income includes interest and short-term capital gains. Dividends and long-term capital gains count as investment income only if you elect to forgo the 15% maximum tax rate on them. Any disallowed interest in one year is carried forward to the next year and can be deducted then if you have enough investment income.
Keogh plans. You can make a tax-deductible contribution of up to 20% of your net earnings from self-employment -- up to $46,000 in 2008 -- in a Keogh retirement plan. The plan must be opened by December 31, 2008, to make a 2008 contribution but 2008 contributions can be made as late as October 15,2009, if you file for an extension of the due date of your return.
Long-term loss. See capital losses.
Loss on an IRA. If you have a loss on your IRA or Roth IRA, you can deduct it as a miscellaneous itemized deduction subject to the 2% limit. You have a loss only if you close all of your traditional IRAs or all of your Roth IRAs and the total distributed to you is less than the total of nondeductible contributions made to the account.
Margin interest. See investment interest.
Nominee interest. If you received interest as the nominee for another person (as you might if you and a sibling co-own a certificate of deposit, for example) and the entire amount of the interest is reported to you on Form 1099-INT, you can deduct the amount that does not belong to you when you report the interest on your return.
Non-business bad debt. See bad debts.
New markets tax credit. This credit is an incentive for investments in entities that lend money to firms in poorer areas. Investors get a 5% credit in the first three years on the money they put up and a 6% credit for next four years.
Penalty-free withdrawals from IRAs and qualified plans. Generally, a 10% penalty tax applies if you withdraw funds from a traditional IRA or company retirement plan before reaching age 59½. There are, however, many exceptions. There's no penalty starting at age 55, for example, if the cash comes out of a 401(k) or other company plan after you leave your job in a year you turn 55 or older. The penalty can also be waived if the money is used to pay extraordinary medical bills, to pay for medical insurance while you're unemployed, to pay for college for yourself or your children, or to buy a first home. Check for any possible exception before paying the 10% penalty.
Penalty for early withdrawal of savings. If you paid a penalty to a financial institution to break a certificate of deposit, you can deduct that amount on line 30 of the 1040.
Roth IRA. For 2008 you and your spouse can contribute up to $5,000 to a Roth individual retirement account if you have that much earned income. Anyone 50 years old or older by the end of the year can contribute $6,000. Unlike a traditional IRA, no one can deduct contributions to a Roth IRA. But, although withdrawals from traditional IRAs are taxable in retirement, withdrawals from Roth IRAs are tax-free. If you contribute to both a traditional IRA and a Roth, the $5,000/$6,000 contribution limit applies to the combination.
Safe-deposit box fees. If you use a safe-deposit box to store your investments, the fee is deductible as a miscellaneous expense to the extent that it and your other miscellaneous deductions exceed 2% of your adjusted gross income.
Saver's credit. Low-income taxpayers who contribute to an IRA or company retirement plan may qualify for this tax credit worth up to 50% of the first $2,000 contributed.
Savings bonds cashed in for education. Interest on EE savings bonds bought after you turned 24 can be excluded from your income if the proceeds are used to pay for college for you, your spouse or a dependent. This break gradually phases out for 2008 as income rises above $67,100 on single returns and above $100,650 on joint returns.
Short-term loss. See capital losses.
SEPs. Self-employed taxpayers can deduct contributions to a Simplified Employee Pension (SEP). The maximum contribution is the smaller of 20% of your net earnings from self-employment or $46,000 in 2008. (It is $49,000 for 2009.) Contributions are due by April 15, 2009, but you can extend the due date to October 15, 2009, if you file for an extension of the due date of your tax return.
SIMPLEs. Small-business owners can also choose a SIMPLE plan for their retirement savings, which stands for Savings Incentive Match Plan for Employees. For 2008, deductible contributions are limited to $10,500 ($13,000 if you're 50 or older by year end) plus 3% of self-employment income. SIMPLE plans generally have to be set up by October 1 of the first year for which you want to make contributions.
Spousal IRA. Generally, to contribute to a traditional or Roth IRA, you must have income from a job or self-employment. But, a working spouse can contribute up to $5,000 of his or her earned income to an IRA for a non-working spouse. The limit is $6,000 if the account owner is age 50 or older by the end of the year.
Stepped-up basis. If you sold property you inherited, be sure you take advantage of a rule that saves taxpayers billions of dollars each year. The tax basis of inherited assets -- such as stocks, bonds, mutual funds and real estate -- is generally the assets value on the date of death of the previous owner. The tax on all appreciation while he or she owned it is forgiven. This rule does not apply to inherited retirement plans; if you inherited such a plan, you are taxed on withdrawals just as the original owner would have been.
Travel to see your broker. If your trip is just to check on the market, there's no tax deduction. But if you visit your broker to discuss your specific investments, you can deduct 50.5 cents a mile for visits during the first half of 2008 and 58.5 cents per mile for use of the car in July through December, plus the cost of parking and tolls. This is a miscellaneous expense, deductible to the extent all your miscellaneous costs exceed 2% of your adjusted gross income.
1244 losses. You can claim favorable tax treatment for stock in corporations that are capitalized with less than $1 million. Up to $100,000 of loss incurred on such stock is fully deductible as an ordinary loss on your return. The loss is not subject to the usual $3,000 cap on excess capital losses. The corporation must be involved in an active trade or business such as manufacturing or mining for its stock to qualify for this treatment.
Worthless securities. If you owned securities that became completely worthless during the year, you claim a loss as if you had sold the securities on December 31 for $0.
See our other taxopedias.