Stocks
You
must have a margin account to make a short sell so you are subject to
margin calls if the stock increases quickly. Your broker can call back
the stock at any time. Profits are taxed as short-term capital gains.Some
companies choose to distribute dividends, which are taxable payments
given by a company to its shareholders out of the company's current or
retained earnings. If the dividends paid are in the form of cash, those
dividends are taxable. When a company issues a stock dividend, not cash,
you do not have any tax consequences until you sell those shares.Stock SplitsA
Stock Split is the increase in number of outstanding shares of a
company without any change in the shareholder's equity or market value.
For example, if a company decides to give its current shareholders 2
shares for every 1 share that they currently own, each shareholder's
proportion of ownership in the company won't change .
When
you sell a stock at a profit you incur capital gains taxes, which are
calculated according to the amount of time that the stock is actually
held. There are other considerations when investing in stocks.Selling short
is borrowing a security (or commodity futures contract) from a broker
and selling it, with the understanding that it must later be bought back
(hopefully at a lower price) and returned to the broker. SEC rules
allow investors to sell short only on an uptick or a zero-plus tick, to
prevent "pool operators" from driving down a stock price through heavy
short-selling, then buying the shares for a large profit. Short sells
can have unlimited losses; you can only short a stock that has moved by
at least 1/16.
There
are no tax consequences when a stock split occurs, but you should be
aware of pre-split and post-split prices for tax calculations of
determining gains/losses.Employee Stock OptionsEmployee
stock options are an increasingly popular compensation perk, allowing
employees to purchase shares of their employer's company at a specified
price by a specific date. There are two different types: non-qualified
stock options (NQSOs) and incentive stock options (ISOs). Taxes depend
on the particular type of option, the holding period of the stock, and
your marginal tax rate.When
you exercise a NQSO, you owe ordinary income taxes on the difference
between the market price and the exercise price. If you do not
immediately sell the shares and hold them for more than a year, you will
be taxed at the lower capital gains rate on any further profits when
you sell.ISOs,
on the other hand, are taxed as capital gains rather than ordinary
income. If you hold the shares for at least 1 year and do not sell the
shares until at least two years after your company issues the options to
you, the gains are taxed as long-term capital gains.
If
you hold the shares for under a year, you will incur the higher
short-term capital gains tax rate. Exercising ISOs could also trigger
Alternative Minimum Taxes(AMTs) . If the difference between the exercise
price and the market price of the stock at the time of exercise is a
positive adjustment to your income, then it is calculated for
Alternative Minimum Taxes; if this is larger than your regular tax bill,
you have to pay this tax.In
the case of ISOs, it is said that the sale of stock is a qualifying
disposition if you owned the stock for at least two years after the
grant date and at least one year after the exercise date.
A portion of the gain is considered ordinary income and will be reported as earned income. Any additional gain is considered a capital gain. A disqualifying disposition happens when you owned the stock for two years or less after the grant date or for one year or less from the exercise date. In this, your employer will report the bargain element (market price at the exercise date minus the actual price paid for the stock, multiplied by the number of shares) as compensation. Any additional gain is considered capital gain.
A portion of the gain is considered ordinary income and will be reported as earned income. Any additional gain is considered a capital gain. A disqualifying disposition happens when you owned the stock for two years or less after the grant date or for one year or less from the exercise date. In this, your employer will report the bargain element (market price at the exercise date minus the actual price paid for the stock, multiplied by the number of shares) as compensation. Any additional gain is considered capital gain.
Mutual Funds Share holders receive all the income or profits realized by a mutual fund . There are two forms of distribution:
- Income Dividends (interest and dividends generated by a fund's investments).
- Capital Gains (the fund subtracts its capital losses from its capital gains to determine its net capital gains, which it distributes to shareholders)
Mutual
funds do not pay taxes on the capital gains from its investments;
instead, share holders pay capital gains taxes, whether or not the gain
is distributed for a particular year. Mutual fund distributions are
reported to shareholders and to the IRS by the fund on Form 1099-DIV or a
substitute statement. Income dividend distributions and short-term
capital gains are taxed as ordinary income at your marginal tax rate.
Distributions of long-term capital gains are taxed at the minimum rate. Reinvested distributions are taxed in the same way as distributions paid to the share holder. If dividends are reinvested, the cost basis of the shares is increased, therefore reducing your taxes when you sell the fund. Remember to include dividends in the cost of your investment or you might pay taxes on gains you never realized.
There are some things you can do in order to avoid getting hit with a big tax bill:
Distributions of long-term capital gains are taxed at the minimum rate. Reinvested distributions are taxed in the same way as distributions paid to the share holder. If dividends are reinvested, the cost basis of the shares is increased, therefore reducing your taxes when you sell the fund. Remember to include dividends in the cost of your investment or you might pay taxes on gains you never realized.
There are some things you can do in order to avoid getting hit with a big tax bill:
- Look for funds with low turnover; sometimes funds buy and sell constantly in an attempt to maximize returns and generate big distributions, but these are subject to taxes, which will cut into your gains.
- Use tax-deferred accounts for tax-inefficient funds.
- Buy and hold; the more you sell or exchange shares, the more capital gains you are likely to realize, so seek long-term capitalgains.
- You can invest in other types of funds. Index Funds simply follow a stock index like the S&P 500. Since the turnover is lower than 40%, they have lower taxable distributions. Tax-Managed or Tax-Efficient Funds focus on after-tax returns; their goal is to keep taxable gains low.
Bonds A
Bond is a debt instrument issued for a period of more than one year
with the purpose of raising capital by borrowing. The Federal
government, states, cities, corporations, and many other types of
institutions sell bonds. A bond is generally a promise to repay the
principal along with interest on a specified date.Bonds can be divided into two types, taxable and tax-exempt.
As
the names suggest, taxable bonds are ones for which interest payments
are subject to federal, state, and/or local income tax, while tax-exempt
bonds are bonds whose interest payments are not subject to federal
income tax. These tax-exempt bonds are typically issued by municipal,
county or state governments, whose interest payments are not subject to
federal income tax, and sometimes also state or local income tax. Bonds
that were not issued by the federal government, your state government,
or a local government within your state, have taxable interest on both
your federal and state tax returns. Bonds issued by your state or
county, city or other municipality within your state, are tax-exempt on
your federal and state tax return.
If
the bond was issued by a governmental authority in a state other than
the one where you reside, the interest is taxable on your state income
tax return, but not on your federal return. If it is a Government Bond
(municipal, Treasury, or U.S. Savings bond), the interest is taxable
only on your federal tax return, not on your state tax return. It is
important to note that gains from the sale or redemption of municipal
bonds and U.S. Treasury Bonds are taxable for both federal and state tax
purpose. It is only the interest income that is tax-exempt for the
state return .
Traders
are those investors who hold stocks and securities for a short period
of time (less than a few days or even a few hours). The goal is to
profit from short-term gains in the market. The stock selection is
generally based on things like charting which relate only to the stock
price instead of a fundamental evaluation of the company as a business.
There
are certain benefits of the trader status. Traders can deduct their
interest expense without itemizing; seminar costs can be deducted as
well as home office expenses in connection with investing. One of the
more attractive rules is that if you are a trader and you elect the
Mark-to-Market election you could benefit from additional benefits:
- the wash sale rule does not apply to your trading activity.
- gains are considered income, so if you have a total annual loss, the loss is not subject to the $3,000 loss limitation .
In this
last case, your trading profits are treated as ordinary income, and not
as capital gains. If you make the Mark-to-Market election, you must
identify which stocks are to be treated as an investment. At the end of
the year, any profits made from your stocks are to be reported as income
except for those identified as investments in which case those will be
treated as capital gains (realized or unrealized). This can be an
advantage if you have held a stock for more than a year and the gains
are substantial.
While
there are certain advantages to filing as a trader, you also increase
your risk for an audit. Although the definition of a trader is not very
clear, the IRS can still audit you and determine that you are not a
trader in which case you might end up with additional taxes, interest
and penalties.