Posts Tagged ‘tax planning’

Tax Planning – Stock Investment Strategies – II

In the last couple of posts, we been looking at how Tax planning can have an effect in your tax preparation. We saw the difference between Tax Planning and Tax preparation. We also started digging in deep on how the cost basis and stock selling strategy can save you some money. In the previous post, I started explaining about different types of determining cost basis and will complete in this post. At the end of this post, you will know which methods helps on different situations. So read on.

Check out the cost basis using FIFO method before moving on to read so you can better understand the difference.

Average cost is another method for determining cost basis and is only used with investment/mutual funds. To determine the average cost, the total cost of all shares purchased including any invested dividends is divided by the total number of shares held.


Once this method is used, it must be used each time the taxpayer sells shares in a mutual funds. This method is most effective if the shares purchased first have the lowest cost basis.


Average cost has 2 different ways of calculating according to the stock purchased periods. The single category method is when the investor takes all of the purchase amounts and divides by total number of shares owned. The double category method sorts the total shares owned into a short-term and a long-term holding period. Then, the average cost for each category is identified.


For example, Jan buys the Vanguard growth fund

  • 200 shares on January 3, 2001 at $20/share

  • 300 shares on September 5, 2002 at $25/share

  • 200 shares on April 20, 2008 at $22/share

On Oct 15, 2009 she sold 500 shares at $20/share. What is her cost basis according to the average cost method?


According to the single category average cost method, she would take an average of the purchase prices and divide by the total number of shares owned:

  • 200 shares at $20 = $4,000

  • 300 shares at $25 = $7,500

  • 200 shares at $22 = $4,400

  • Total cost = $15,900

  • Total shares = 700

  • Average cost per share = $22.71

So the gain/loss for this sale was:

  • 500 shares ($20 – $22.71) = -$1135.50

Therefore, Jan had a net loss of = -$1135.50


The specific share identification method implies that specific shares are used to apply against the shares sold.


Before selling shares, the shareholder must inform the broker or fund company regarding which shares are to be sold. These instructions must be given at the time of sale or transfer, not later. The broker or agent must confirm this request within a reasonable time after the sale.


This method can be used effectively only if the shareholder has kept accurate records and has followed through on the receipt of confirmations from the broker. It allows the shareholder to control the capital gains taxes that he or she has to pay because this can be determined by selecting the shares to sell. You can tell your broker to sell your highest-cost shares when unloading part of your holdings in a stock. Using this “specific ID method” requires you to identify the shares to be sold by specifying their cost and purchase dates. You must also receive a written confirmation of your instructions from the broker or keep a record of your oral instructions. Put this in your tax file for safekeeping.


Which method is suitable and when?

Specific ID method is the best method for tax purposes because the investor has absolute control over how much the gain from a sale would be. Long term or short term gains can also be controlled. This is the preferred tax basis method for investors who actively manage their portfolio for tax efficiency. It is also not the most cost effective because of all of the effort that is required for proper record-keeping.


If you don’t follow th procedure, you must use the first-in, first-out (FIFO) method, meaning the shares you bought first are considered sold first. Those were likely the cheapest — giving you the biggest possible tax hit. The point to remember is that you must take action at the time of sale to use the specific ID method.

Short term Vs Long Term

If you have both unrealized gains and losses in your portfolio, but want to make some sales in a certain way matching them property to get the best effect. 
First, the general rule is try to sell long-term holdings (held over 12 months) first to benefit from the 15% maximum long-term capital gains rate. Then, unload your short-term holdings.


Then in order to offer offset those gains, you can sell the loser stocks for loss to balance it out. You will generally get the most tax-saving for the buck by selling short-term holdings for a short- term loss by taking advantage of short-term losses offsetting short-term gains which would otherwise be taxed at the regular income tax rate and any leftovers then offset long-term (15%) gains.

By following the above strategies matching your situation, you can either save some money by not paying to uncle sam way beyond the tax season. That concludes the tax planning – Stock investment strategy by doing cost basis analysis.

Tax Planning – Cost Basis and Investment Strategies – I

Previously, we discussed about the difference between Tax preparation and Tax planning. We saw few examples of simple tax planning strategies which can be adapted to save money.  In continuing witth the tax planning topic, this post we will learn about Cost basis and stock selling strategies with examples that can help you either get more refunds or save paying more taxes. 

What is Stock/Security Cost Basis?

There are actually various different cost basis involved in any investments including stocks. Let see the importance and their role in tax planning.


The Starting Cost basis is actually what a person pays for the purchase of the stock initially, adding any cost of purchase such as commissions. If the person received the stock as an inheritance, the starting basis is the value of the stock on the date the original owner died. This is called a stepped-up basis. Stepped basis is when the donee(who recieves the stocks) gets the  FMV (fare market value) as their starting basis instead of donor’s original basis.


If the stock is given as a gift, the starting basis is the lesser of either:

  • the starting basis of the person who gifted the stock(carryover basis), or

  • the market value of the stock on the date the gift.

Why cost basis important?

When you purchase/inherit/get gifts of stocks/securities, starting cost basis is set accordingly. When those stocks or other securities are sold, the selling price is usually different from the original purchase price of the shares. Either a capital gain or a capital loss is realized during this transaction and must be reported to the IRS by the taxpayer. In order to calculate the amount of capital gains and losses the cost basis of the stock must be determined.

Whether it is a short term or long term capital gain depends on the holding period of the stock/securities. We will discuss about that more later.


There are three different ways to find the cost basis when selling stocks:

  1. First in first out (FIFO)

  2. Average cost method

  3. Specific share identification

First in first out (FIFO) method uses the shares first purchased as the cost basis. This method is effective if the first shares purchased were the most expensive.


The cost of shares is used in the order purchased for determining cost basis according to FIFO method. The oldest shares owed are considered to be the ones that are sold first. This method is the default method that the IRS will assume a taxpayer is following unless otherwise specified in a statement attached to the income tax return.


For example, Investor John buys the following round lots of Apple, Inc.:

  • 200 shares on January 3, 1999 at $71.50/share
  • 300 shares on September 5, 2007 at $160.50/share
  • 200 shares on Apr 20, 2009 at $120.50/share


On September 15, 2010 she sold 400 shares at $200/share. What is her cost basis according to the FIFO method?


According to FIFO, she would exhaust the basis of the shares purchased the earliest first:

  1. 200 shares at $71.50

  2. 200 shares at $160.50

So the gain/loss for this sale was:

  1. 200 shares ($200 – $71.50) = $25,700

  2. 200 shares ($200 – $160.50) = $7,900

Net gain for the sale = $33,600.


Since all 400 shares were held over a year, the $33,600 gain would be subject to long-term capital gains taxes. 


An example of basis in which a gift results in a gain would be as follows:


Ronald gives Jen a round lot of stock as a gift. Ronald paid $10,000 for the stock, and the fair market value (FMV) of the stock is $20,000 at the date of the gift. If Jen sells the stock for $20,000 she will use Ronald’s starting basis of $10,000 is used to report the capital gain.

However, the example above does not apply if Ronald had gifted his stock to Jen when its FMV was $8,000, which is less than his original basis of $10,000. The capital gain or loss reported by Jen depends on whether she subsequently sells the stock for a gain or a loss.


Let’s look another example in which the same gift could result in a loss:

If Jen sold the stock for $15,000 then Jennifer would report a capital gain of $5,000 using Ronald’s original basis of $10,000 to calculate her gain. However, if Jen sold the stock for $5,000 she would report a loss of $3,000 using the stock’s FMV basis of $8,000 to determine her loss. Note that if Jen sold the stock for $9,000 she would not report a gain or a loss in this situation.

Tax Planning Tips:

As per the FIFO method, first purchased stocks are used to calculate the cost basis. If they are purchased cheap, tax liability will be more and you will end up paying lot more in taxes. At the same time, if you are selling for loss, you might get big tax loss deduction. FIFO method is the default method used by any brokers unless you inform them to use different method for sell.


When it comes to gifting, tax planning should be key as well. What to gift, when to gift and how to gift them are important points. If you keep appreciated security and donee sells it immediately, he will end up liable for the big capital gain.

Tax Planning Vs Tax Preparation

As soon as March rolls around, many of us get ready to welcome the Spring season but many worry about the Tax season. I am sure you are among millions of people trying to get your tax return filled and filed away by Apr 15. Many of you might use your good Internet skills and take advantage of online tools like Tourbo Tax or TaxAct to file taxes. Others still don’t believe the online tools does good job in getting you big tax refund and still depend on CPA’s and tax preparers for tax help.

Either way, you will only get what you can get  and you cannot change anything now at this point to get more tax refunds than eligible.  Some don’t understand, it is too late to think about getting more tax deductions unless you planned in advance. You can only reduce taxes so much by either by taking deductions or using credits. That’s where Tax planning comes into play a key role.

Tax planning is many times confused with tax preparation, with only thought given to planning when preparing their annual tax return. However, little can be done to actually reduce your tax bill at that point. If your aim is to reduce taxes, you need to be aware of tax planning opportunities throughout the year.


Take time in the early part of year, may be during tax preparation process, to assess your tax situation, and look for ways to lower your tax bill. Consider a list of items, such as what kinds of debt you owe, which investments you own and need to dispose,  how you are saving for retirement and kids education expenses and what tax-deductible expenses you incur. Also deciding whether you want to file separately or jointly, timing the sale of your capital assets, deciding on period of withdrawal of retirement funds, the timing and amounts of giving gifts  and when to pay expenses are some examples of tax planning.

By thinking about tax consequences during the year on every big financial moves will prevent you from finding out later that there was a better way to handle every transaction.

Here are few examples  of tax planning which might help you either to get better refunds or avoid shelling out on taxes during the filing time.


1. If you are an employee, you can avoid paying at the end of the year by increasing your tax withholding. It actually changes the mind set from “how much need to pay” to “how much I will get back as refund”. But the problem is, more money will be taken out of your paycheck throughout the year and you need adjust your budget accordingly. That may sound like a good strategy but at the same time you don’t want to give away Uncle Sam interest free money by withholding too much. A nice realm check is to use this year’s return and keep the all deductions constant and see whether you withholding is right level. If you got too much refund reduce the withholding proportionately, on the other hand if you paid tax, increase your withholding accordingly.

2.  If you have a stock which you been waiting for years to bounce back up but never seen any signs, don’t lose heart. That loser stock can still bring you money by reducing your tax burden. Just wait till the end of year and sell it if you don’t see the sunlight for the stock. Buy selling the loser stock for loss, it helps to wipe out the realized capital gains for the year, plus take another $3,000(married filed jointly) in regular income. But there is a caveat to it. You cannot just sell the loser stock and buy the same stock with before or after 30 days of the sale. Then the losses you realized previously gets disallowed because it’s considered a wash sale.

3. If you are expecting big medical expenses for that calendar year, you should be able to itemize the deduction by keeping track of the transactions and even medical miles driven. In order to do that, you need to plan and remember to save all the reciepts of the expenses like hospital charges, copays, medicines&prescription cost and much more. Track the medical miles driven and also add them in the deduction. Add these medical deductions on top of the health insurance paid from your pocket.

These are just few samples and there are lot more too tax planning. Will cover some more in the next article.

Useful tax planning sources:
Small Business – http://www.answers.com/topic/tax-planning-in-accounting
Personal Planning – http://www.raymondjames.com/taxplan.htm

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