Financial Backers

 Financial Backers

Even for tax experts, understanding the intricate regulations put in place by the Internal Revenue Service (IRS) regarding investment taxes can be a real challenge. There are many potential pitfalls, and the consequences for even little errors can be rather serious. Here are five typical tax blunders to avoid making as April 15 approaches, so you can keep more of your hard-earned money.
1. Not Recouping Losses

Gains from the sale of investments are often subject to taxation. Your tax bill can be reduced in part by liquidating some of your lost investments. You can then utilize the money you lost to reduce the money you made.

Imagine you are the proud owner of not one but two stocks. The first stock gives you a $1,000 gain, while the second stock gives you a $1,000 loss. The $1,000 gain from selling your winning stock will be subject to taxation. However, you will lose $1,000 more than you earn $1,000 if you sell both stocks. That is great news from a tax perspective because it means neither job will cost you a dime.

This plan seems reasonable, does not it? Yes, it is, but there are some complexities you should be aware of. The "wash sale rule" states that you cannot deduct the loss on the sale of losing stock if you repurchase it within 30 days. Not only is it illegal to buy the same stock again, but you can not buy any stock that is "substantially identical" to it, a term that investors and tax experts both find nebulous and confusing. Lastly, before anything else, you have to balance your long-term and short-term profits and losses, according to the IRS.

2. Mutual Fund Basis Miscalculations

The process of determining a profit or loss when selling a single stock is simple. Gain or loss can be calculated by subtracting the amount you paid for the shares (including commissions) from the net proceeds from their sale, which is known as your basis. When dealing with mutual funds, though, things become more trickier.

One common mistake people make when figuring their basis after selling a mutual fund is not including the distributions of capital gains and dividends that were reinvested in the fund. When these distributions are made, the Internal Revenue Service treats them as taxable earnings for that year. Consequently, you have already deducted their tax value. If you do not include these dividends in your basis, you would report a bigger gain than what you actually earned from the sale, leading to unnecessary tax payments.

Being meticulous with your record-keeping and dividend/distribution organization is the only surefire way to avoid this headache. While the additional paperwork may be a pain, it may end up saving you money when tax time rolls around.

3. Ignoring Accounts Managed by Taxes

The vast majority of mutual fund holders are in it for the long haul. So it comes as a shock to them when they receive a tax bill for the short-term gains their money made. Shareholders are required to record these profits on their personal tax returns, regardless of whether they actually sold their mutual fund shares, because they are the consequence of sales of stock that the fund held for less than a year.

An increasing number of mutual funds have made tax management a priority as of late. In addition to investing in solid companies, these funds aim to reduce shareholders' tax liability by keeping their shares for long periods of time. You can enhance your net gains and avoid tax-related hassles by investing in funds that aim for "tax-managed" returns. However, for a tax-efficient fund to be worthwhile, it needs to have minimal taxable distributions to shareholders and outstanding investment performance.

4. Due Dates Not Met

To make your investing dollars go farther and save for retirement, consider a Keogh plan, a standard IRA, or a Roth IRA. Millions of investors lost out on these treasures because they did not pay their taxes by the due dates. December 31 is the cutoff date for Keogh plans. The deadline for contributions to both regular and Roth IRAs is April 15. Please ensure that you make the necessary deposits by the specified dates.

5. Using Incorrect Accounts for Investments

There are two main kinds of investment accounts that most people have: regular and tax-advantaged ones. The correct asset allocation across all of your accounts can help you avoid paying thousands of dollars in unnecessary taxes every year, but few individuals know this.

For the most part, you should keep dividend-paying investments or those with long-term capital gains in regular accounts, and those with high taxable income or short-term capital gains in tax-advantaged accounts.

Imagine, for the sake of argument, that you are the proud owner of 200 Duke Power shares and plan to hang on to them for a while. Aside from the quarterly dividend payments that are subject to taxes at a rate of 15% or lower, this investment will also produce a long-term capital gain or loss that, upon sale, is also subject to taxes at a rate of 15% or lower. There is no need to put these shares in a tax-advantaged account because they already receive favorable tax status.

Treasury and corporate bond funds, on the other hand, typically provide interest income on a consistent basis. Your marginal tax rate will apply to this income because it does not meet the criteria for preferential tax treatment, such as dividends. If you are not in a particularly low tax rate, putting these cash in a tax-advantaged account will let you put off paying taxes for a long time, if not forever.

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