Month: November 2013

Turn Your Stock Losses Into Tax Savings

Income tax expense is the largest expense you’ll encounter in your life, bigger than your mortgage or the cost of getting through college. There is however, a way to offset your tax expense with your capital losses.

It could be to your financial advantage to finally sell the stock that will most likely never recoup and turn that investing disappointment around by claiming the loss against any capital gains you might have for the tax year. You will end up not paying any tax on your positive returns on investment. Most taxpayers will be taxed at a 15% rate on long-term capital gains. More affluent taxpayers will be taxed at a 20% rate. Therefore, you’re saving by not paying the IRS and it’s totally legal.

If you don’t have any capital gains, you can deduct up to $3,000 of your capital losses against ordinary income for the tax year. Ordinary income is defined as income received that is taxed at the highest rates and is composed mainly of wages, salaries, commissions and interest income. Any excess can be carried forward indefinitely for use in reducing your taxable income in upcoming tax years.

This could be a deal breaker for some when it comes to staying or dropping out of the stock market. If an individual makes calculated decisions and shows capital gains in the future, they will recoup their capital losses faster than if they would just rely on ordinary income to replace the money they’ve lost.

Rules for corporations looking to catch a tax break on their capital losses differ from rules that apply to individuals.

First of all, capital gains are not taxed at lower, preferential rates for corporations. Even though individual taxpayers pay less tax on their capital gains than on ordinary income, corporations pay the same amount. Furthermore, both corporations and individuals can deduct the capital losses against capital gains they’ve received during the tax year but corporate taxpayers cannot deduct their capital losses against their ordinary income. They can carry the excess capital loss back three years and forward five years. After five years, the corporation will not be able to take advantage of the tax savings. So, if the tax payer does not completely use up the capital loss by the end of the carry-forward period, it will be lost forever. Also, the carry-back of a loss must not increase or result in a net operating loss for the year to which it is being carried back. In that case, it must only be carried forward.

All in all, do not be quick to exit the stock market if you had a bad year. Sometimes stock losses can be turned into tax savings.

The Tax Benefits of Life Insurance

Life insurance can be the most important purchase a person will make in their life. (Life insurance is defined as the contract between an insurance policy holder and an insurer, where the insurer promises to pay a designated beneficiary a sum of money upon the death of the insured person.) It can help protect the insured person’s family from excessive costs that may pile up after his/her death, finance children’s education, allow to continue a business or replace lost income. What a lot of people don’t know is that life insurance also may accumulate cash value and offers some tax advantages, which I will describe below.

1. An insured person’s beneficiary (a person who receives proceeds from the life insurance policy) does not pay any federal income tax on death benefits received. So, a beneficiary will obtain the full amount of $250,000 from a $250,000 insurance policy. The IRS does not require any deductions or withholding from beneficiary’s proceeds. In fact, the benefits received are not included in the calculation of their gross income and do not have to be reported.

2. If an insured person transfers the ownership of their life insurance policy to another person, they will avoid paying estate taxes on life insurance death benefits. In order for that to happen, the transfer must take place three years prior to an insured person’s death.

Side note: according to the IRS, “The Estate Tax is a tax on your right to transfer property at your death. It consists of an accounting of everything you own or have certain interests in at the date of death. The includible property may consist of cash and securities, real estate, insurance, trusts, annuities, business interests and other assets. Once you have accounted for the Gross Estate, certain deductions (and in special circumstances, reductions to value) are allowed in arriving at your Taxable Estate. A filing is required for estates with combined gross assets and prior taxable gifts exceeding $5,250,000 in 2013.” Therefore, only those people who leave behind over 5 million dollars need to worry about the estate tax.

3. Finally, a life insurance policy that can accumulate cash benefits for it’s owner is called permanent insurance and generally provides coverage for the duration of the insured person’s life. The premium amount remains the same for the life of the policy, and accumulates cash value. This cash value is available to the insured through policy loans. As the cash value builds up, the insured does not have to pay any current federal income tax. In addition, after a big enough amount of cash value has accumulated, the insured can borrow from it to supplement their retirement income.

In my next blog post I will talk about capital losses and how the IRS can help you reduce the financial burden through tax breaks. This might be one of the main reasons to remain in the stock market and recoup your losses faster.