How to Determine the Gain on Sale of Stock

Now that the new year is upon us, I’m sure many are wondering about that important question, how to calculate your gain (or loss) on a sale of stock.  Because stock shares are fungible (interchangeable), it is somewhat difficult to know how to pair the sales and buys.  The following is what I’ve learned from my experience and should be used as a guide only.  Go to a CPA to check and make sure the information is right and nothing has changed (if you are buying and selling stock, you need a CPA).  This is not meant to be tax advice.

There are three ways to calculate the gain for a stock.  You can pick any of these ways to calculate the gain, but once you start, you must use the same method for the whole position.

Average Price (Cost Basis):  In this method, you use the average price you paid for the shares.  Obviously just take the amount you paid  for each transaction, sum them up, and divide by the total number of shares.  Note this is the net amount paid – after you paid commissions to the broker.

First In- First Out:   In this method, you assume the first shares you bought were the ones being sold.  For example, if you bought 100 shares in January, 100 in March, and 100 in June, when you sell the first hundred shares you match them with the shares you bought in January.  Once again you subtract what you bought the shares for from what you sold the shares for.  Always use the cost after commissions.  This is generally the worst way to sell shares because if you’ve done well, the price of the first shares you bought will be lower than the price of subsequent shares. If the first shares have been held long enough to be a long-term gain, while newer shares are a short-term gain, this is a good method.

Versus Purchase:   The third method requires you plan things as you sell the shares.  In this method, you tell your broker which shares you are selling, and he/she put in a “versus purchase” order.  In that case you sell a specific set of shares and use the cost of those shares in the  calculation.  This is probably the best method of all since it allows you to sell the shares with the highest cost basis, minimizing your gains.  It does take planning, however.

Once again, please use the above as a guide only and check with a professional.  Also, if there are any professionals out there who see an error, please let me know.

Please send investment questions to vtsioriginal@yahoo.com or leave them in a comment.

Follow me on Twitter to get news about new articles and find out what I’m investing in.  @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

Reducing Your Taxes for 2011

There are only a few days left in 2011.  The new year starts on Sunday.  If you have not done so already, this is the time to make the financial moves to save money on your taxes.  By next week, it will be too late for 2011.

Note:  As the disclaimer for this blog shows, I’m not a CPA.  Tax laws are very complicated and change frequently (even the IRS gets them wrong from time-to-time.)  You therefore should consult a CPA to verify the rules before you make a costly mistake.  The following are just things I’ve learned from experience in managing a portfolio.

The basic rule for tax planning is to delay gains and pull losses forward.  This means that it is generally better to get all of the deductions and take all of the losses you can in the current year and delay making gains until next year (or longer than that if you can).  This is not true if, for example, your income is going to double next year so you will be in a higher tax bracket, but it is a good general rule for most people.

Based on this philosophy, here are some things to do this week:

1.  Scour your portfolio for losing positions.  If you feel that the underlying fundamentals of the company have changed such that it is time to sell anyway, do so this week so that you can bank the loss in 2011.  If you also have gains in stocks and the positions have become so large that you would like to trim them back, you can sell some shares at a gain and directly offset your gains with your losses.  You can also offset about $3000 worth of other income and carry the losses forward to offset income in other years if your losses exceed this amount.  Again, check with a CPA on the specifics since this can get very tricky.

2.  Make sure you have fully funded your children’s college accounts.  This may not reduce your taxes now, but it increases the amount of money you will have to withdraw tax-free when your kids are ready to go to college.

3.  Make last-minute contributions to IRAs and Roth IRAs (you actually have until April to make these contributions, but why not get them out-of-the-way early to make sure you don’t forget or do something else with the money).

4.  If you have a losing position but would like to keep the shares (you feel the company has good long-term prospects even though the price has been beaten down) you might consider selling the shares for the loss and then buying them back later.  Note that you must wait at least 30 days before buying them back or you will have a wash sale and not be able to deduct the loss.  Note that you also can’t buy additional shares now and then sell the shares for the loss – you also have to wait 30 days after you bought the shares.

The issue with selling shares in a stock you like is that the company may take off after you sell before you are able to buy in again. You also might buy something else with the money while you are waiting and never get back into the company again. If there is another company in t e same industry that you also like, consider buying it with the proceeds of the sale. For example, if you own shares of Coke at a loss, you might sell them and buy Pepsi.

5.  The wash sale rule does not apply if you are selling your shares at a gain (you can always take a gain and rebuy the shares whenever you wish).  If you have a stock that has a large gain you might consider selling some shares and taking part of your gain now to split up the gain over different years.  Assuming you have held the shares long enough to have a long-term gain the taxes are fairly low currently.  If you still like the stock, buy it back immediately to avoid missing the future success of the company.

Note that you might delay selling the shares until next week to delay the gain into next year, but then again tax laws may change next year.  Some of these laws apply retroactively to snag profits made early in the year.

6.  Pay your property taxes on your home before the end of the year to bring the deduction into 2011.

7.  If you have shares in a stock that has gone way up and you are now afraid it may fall, consider selling short-against-the-box.  In this strategy you short the same number of shares you would like to sell and then allow the shares to wash out after the new year.  This will lock in your profit (but you will also lose the ability to profit further if the shares rise).

8.  Another strategy if you have a stock that has gone up a lot is to buy a January put option.  This will give you the right  to sell the shares at a predetermined price between now and mid January. This will lock in your profit but still allow you to participate, should the shares rally further.  Typically such put options (assuming you buy one just below the current price of the stock) cost between $100 and $200 per hundred shares.

Take some time now to save money on your taxes in April.

Please send investment questions to vtsioriginal@yahoo.com or leave them in a comment.

Follow me on Twitter to get news about new articles and find out what I’m investing in.  @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

Reduce Your Taxes. Four Steps to Take Now.

With the New Year approaching, now is the time to make sure you are getting all of the tax benefits you can.  Remember it is almost always best to delay income and pull loses and deductions forward.  Here is a list of things to consider:

1.  Sell losing positions in your portfolio.  Remember that you cannot buy them back for 30 days (or sell them if you bought within 30 days), of you will have a wash sale and not be able to deduct it.  Instead, wait the time out or buy another similar stock.

2.  Max out your retirement account contributions.

3.  Max out you educational IRA contributions and other college savings accounts.

4.  Be sure to spend remaining funds in use-it or lose-it health spending accounts.  If you need new windows or a heating unit, buy one before the end of the year and check on savings for installing energy-efficient models.

Don’t wait until January or you will lose the opportunity.

Your investing questions are wanted.  Please send to vtsioriginal@yahoo.com or leave in a comment.

Follow me on Twitter to get news about new articles and find out what I’m investing in.  @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

How Buffett will Avoid the Buffett Rule, and You Can Too

Ask SmallIvy:  Please send investing questions to vtsioriginal@yahoo.com or leave in a comment.

Warren Buffet, the Sage of Omaha, has been complaining lately that his tax bill is not high enough.  He famously talked about how his cleaning lady (later changed to his secretary when the story is retold by others) pays a higher tax rate than him.  He has said that the wealthy should pay more in taxes.

As a result, the Obama administration has released what they call the Buffett Rule.  This is a new tax on those making more than a million dollars.  The trouble is that Warren Buffett did not make a million dollars last year.  In fact, he didn’t even pass the $200,000 threshold that President Obama has cited as “rich.”  He only made a salary of about $180,000.  So what gives?

The issue is that Mr. Buffett does not take a large salary.  Instead, most of his wealth is tied up in long-term capital gains in Berkshire Hathaway stock (the ones who bring you the talking gecko commercials).  This means that he pays no income taxes on his most of his wealth, despite being worth billions of dollars, since that is only a paper profit until he sells the shares.  So, unless there is a tax on wealth, he will continue to pay a lower tax rate than his cleaning lady.  (Note that the companies he owns stock in pay a fairly large 35% income tax, which affects his share prices.  He therefore is actually paying taxes on his wealth, as are all investors, which is the reason for the argument for lower capital gains taxes.  The point here is that the Buffet Rule will not cause Mr. Buffett to pay any more taxes).

But at least when he dies the wealth will be taxed as the money is inherited by his children right?  Not exactly.  You see, Mr. Buffett, like many billionaires, has created a foundation in his name and given a few billion to his foundation.  (Originally he was going to give most of his wealth to the foundation, but decided later to give the bulk to the Bill and Melinda Gates Foundation).  The foundation can then hire his children.  They can work in a big foundation-provided office, live in the foundation-provided houses, drive the foundation-provided cars, and take foundation-provided trips in foundation provided airplanes to perform “research” for the foundation.  He has been able to use his wealth to set his children, and probably his grandchildren up for life without ever paying a dime of tax on this wealth.

So, what can be learned besides the hypocrisy behind the Buffett Rule?  One can learn is that by buying stocks long-term and holding onto them, one can avoid personal income taxes almost indefinitely.  One can even avoid paying personal income taxes ever if the proceeds are given away to a qualified charity or, if wealthy enough, one sets up a foundation.  While it seems  exciting to trade stocks regularly, all you are doing is generating brokerage commissions and taxes.  To really use the tax-deferral properties of common stocks, invest for the long-term.

Have a burning investing question you’d like answered?  Please send to vtsioriginal@yahoo.com or leave in a comment.

Follow on Twitter to get news about new articles.  @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

Implementing The Fair Tax

A while back, probably right after I’d finished filling out my income tax forms for 2010, I made a post about a tax idea called the Fair Tax.  The beauty of the Fair Tax is that it would eliminate all of the hassles involved in paying taxes.  Income taxes, Social Security, and other Federal taxes would be replaced by a single sales tax on goods and services when purchased (a national sales tax).  Because taxes would be figured out and charged automatically when you purchased something, you would no longer need to keep track of expenses, have tax deferred accounts, set up medical savings accounts, 401ks, IRAs, etc… and go through other hassles.

You would simply receive your whole paycheck each month and then spend or save as you chose.  One benefit beyond the simplification of tax compliance is that saving would be rewarded while spending would be penalized.  The current system encourages spending and borrowing, through tax breaks for things like business expenses and the mortgage deduction, and penalizes earning.  This means that under the current system there is a disincentive to grow businesses or work harder because more of your income is taken the more you earn.

The Fair Tax is prevented from being regressive, or level in any case, through the use of a prebate.  In the prebate, a certain amount is refunded to each person each year at the beginning of the year.  For example, if the sales tax is 10%, and $3000 were prefunded to everyone each year, then no one earning less than $30,000 would pay any taxes that year ($30,000*10% = $3000), even if they spent their entire paycheck on taxable goods and services.

One issue with implementing the Fair Tax is the radical change to the tax system.  We have spent so many years having taxes taken from our paychecks and doing things to reduce income taxes that it would be a big shock to the system to see it changed overnight.  Imagine the shock of going to buy a new car and seeing a 20% tax added to the top of it!  Never mind that you have 20% more cash in you pockets – you still see that big tax on the car.  You were paying tha big tax before, but it was taken in small increments so you did not see it all at once.  There is a way, however, to implement the tax in a way that will be a smaller shock on the system.

Currently about 50% of people pay no income tax at all.  In fact, many get cash given to them by the tax system since they receive a refund through the Earned Income Tax Credit.  This means that implementing the Fair Tax to replace the tax payments of the lower 50% of earners would not require a large sales tax since the amount of revenue collected from them is mainly Social Security and Medicare, which aren’t large amounts of money.  Also, implementing the Fair Tax would enable taxes to be collected from those who currently don’t pay taxes – those who get paid under the table and/or have illegal sources of income (drug sales, prostitution, illegal labor) - since they would also be charged the sales tax when they spent the ill-gotten money.

If the Fair Tax were implemented only on people making $60,000 per year of less say, it would only be necessary to have a sales tax of about 5% or less.  This means that everyone would see a prefund each year of $2000 (5% x $40,000) and see their sales taxes increase by about 5%, assuming that it is desirable to continue to see 50% of the people pay no income taxes.

After a few years of seeing those at the low-income levels not need to file taxes and also seeing how the system worked, those in the middle and upper-middle classes would probably want to join the system.  The threshold for the Fair tax could be then be  ratcheted upwards as political winds allowed.  The prefund would need to be ratcheted upwards as well since the level of the sales tax would need to increase as the income level of the Fair Tax threshold increased.  This is because  in order to generate the same level of revenues the sales tax percentage would need to increase since those at the higher income levels are paying a larger portion of the taxes.  If the Fair Tax were ever to fully replace the income tax, including for those in the top 1% of earners, the rate would be about 23%.  It is thought, however, that the drop in the expenses paid by businesses for tax compliance and tax avoidance would allow them to charge less for the goods and services; therefore, the actual price of the goods might stay about the same.

If you like this idea, please tell a friend – let’s get rid of the IRS!

Your investing questions are wanted.  Please send to vtsioriginal@yahoo.comor leave in a comment.

Follow on Twitter to get news about new articles.  @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.