Stocks, Bonds and Mutual Funds - Thomson Reuters

Stocks, Bonds and Mutual Funds

Tab 6 Planning Topics

3.8% Net Investment Income Tax............................ Page 6-1 Capital Gain Rules................................................... Page 6-1 Qualified Dividend Tax Rate..................................... Page 6-3 Taxable vs. Tax-Exempt Returns............................. Page 6-4 Treasury Bills........................................................... Page 6-5 Discount Bonds........................................................ Page 6-6 Premium Bonds....................................................... Page 6-7 U.S. Savings Bonds................................................. Page 6-8 Swapping Bonds to Claim Losses........................... Page 6-9 Private Activity Bonds and AMT............................. Page 6-10 Inflation-Indexed Bonds......................................... Page 6-10 Stocks--Share Identification and Holding

Periods................................................................ Page 6-11 Small Business (Section 1244) Stock Losses....... Page 6-13 Qualified Small Business Stock............................. Page 6-14 Wash Sales............................................................ Page 6-16 Worthless Securities.............................................. Page 6-17 Fraud and Embezzlement Losses......................... Page 6-18 Publicly Traded Securities--Deferring Gain.......... Page 6-18 Stock Dividends and Stock Splits.......................... Page 6-19 Constructive Sales................................................. Page 6-19 Investors vs. Traders............................................. Page 6-20 Mutual Funds......................................................... Page 6-22 Calls and Puts........................................................ Page 6-25 Investment Expenses............................................ Page 6-28 Investments and Investors--Definitions................ Page 6-30

3.8% Net Investment Income Tax

Beginning in 2013, high income taxpayers will pay an additional 3.8% tax on the lesser of their net investment income or their modified AGI in excess of a threshold amount (based on filing status). Net investment income includes capital gains, dividends, taxable interest and other forms of unearned income. See 3.8% Net Investment Income Tax on Page 13-1 for details on the tax. For how the NII tax applies to stock traders, see Traders and the Net Investment Income (NII) Tax on Page 6-22.

Capital Gain Rules

Capital Gain Rates

For 2013, the following capital gain rates apply: 28% rate. The 28% maximum tax rate applies to (1) gain from the sale of collectibles held more than one year and (2) the taxable portion of gain from the sale of qualified small business stock (QSBS) held more than five years (see Qualified Small Business Stock on Page 6-14). 25% rate. The 25% maximum tax rate applies to unrecaptured Section 1250 gain on sales of depreciable real property held more than one year. To the extent a taxpayer is in a tax bracket below 25%, the lower tax rate applies. See Tab 7 for more on unrecaptured Section 1250 gain.

20% rate. The 20% rate applies to long-term capital gains (other than those described under 28% rate and 25% rate in the previous column) when the taxpayer's taxable income is greater than the following amounts:

? Single: $400,000

? HOH: $425,000

? MFJ: $450,000

? MFS: $225,000

The 20% rate applies to the lesser of the gains or taxable income in excess of the threshold amounts. The 20% rate also applies to qualified dividends.

15% (0%) rates. The 15% tax rate (0% for taxpayers in the 10% and 15% ordinary income brackets) applies to the sale of assets held more than one year to the extent the taxpayer's taxable income does exceed the threshold amounts shown under 20% rate above. The 15% (or 0%) also applies to qualified dividends. See Planning for the Capital Gain Rates on Page 6-3.

Capital Gain and Dividend Tax Rates--2013

Section 1(h) and 1223(3) and (4)

Holding

Ordinary Tax Rate Bracket

Period 10% 15% 25% 28% 33%1 35%1 39.6%1

Capital Gains Short-term 1 year 10% 15% 25% 28% 33% 35% 39.6%

Long-term > 1 year 0% 0% 15% 15% 15% 15% 20%

Unrecaptured Section 1250

> 1 year

10%

15%

25%

25%

25%

25%

25%

Collectibles > 1 year 10% 15% 25% 28% 28% 28% 28%

Qualified

Small Business

> 5 years 10% 15% 25% 28%

28%

28%

28%

Stock2

Dividends Qualified > 60 days3 0% 0% 15% 15% 15% 15% 20%

Other 60 days3 10% 15% 25% 28% 33% 35% 39.6%

1 Capital gains and qualified dividends for taxpayers in these tax brackets will likely also be subject to the 3.8% tax on net investment income (see 3.8% Net Investment Income Tax on Page 13-1).

2 50% of the gain from the sale of qualified small business (Section 1202) stock is excluded so the maximum effective rate is 14%. (Exclusion is 60% for certain businesses in empowerment zones.) The gain exclusion is greater for QSBS acquired in 2009?2013--see Gain Exclusion for the Sale of QSBS on Page 6-15.

3 90 days in the case of preferred stock.

Other Capital Gain Rules

Installment sales. Installment sale gains are taxed based on the tax rates in effect on the date an installment payment is received, not the rate that applies at the time of sale. [Sanford, 76 AFTR 2d 95-5585 (5th Cir. 1995)]

Capital losses offset capital gains and, to the extent there is an excess loss, up to $3,000 ($1,500 MFS) can be deducted against ordinary income each year [IRC ?1211(b)]. Any remaining loss is carried forward indefinitely to future tax years.

Grouping gains and losses. When a taxpayer has both capital gains and losses that are subject to different tax rates, the capital gains and losses are first grouped into long-term and short-term

2013 Edition | Tax Planning for Individuals Quickfinder? Handbook 6-1

Comparing SIMPLE IRAs, SEPs and Qualified Retirement Plans (2013)

Feature

Profit Sharing

401(k)

SIMPLE IRA

SEP

Who can adopt?

Generally, any employer or self- Generally, any employer or self- Employers with 100 employees Generally, any employer or self-

employed.

employed.

earning at least $5,000 in prior employed.

year.

Can employer maintain

Yes

Yes

No

Yes, unless Form

other qualified plans?

5305-SEP is used to adopt the

plan.

Employees who must be allowed to participate

Age 21 and older. Up to one year Age 21 and older. No more than

of service may be imposed.

one year of service may be

required for employee deferrals.

All employees earning at least Age 21 and older with any

$5,000 in any two prior years and service in last three out of five

expected to earn at least $5,000 years and compensation of $550

in current year.

or more in current year.

Vesting

Graduated or cliff vesting allowed.

Graduated or cliff vesting

100% immediate vesting.

allowed. Employee contributions

are 100% vested.

100% immediate vesting.

Employer contribution requirement

Discretionary, unless set forth in plan.

Discretionary, unless set forth in plan.

? Dollar-for-dollar matching contribution, up to 3% of compensation or

? 2% of compensation (up to $255,000 per employee) contribution for all eligible employees.

Discretionary

Limit on deductible employer contributions

25%1 of eligible compensation 25%1 of eligible compensation Limited to required matching or 25%1 of eligible compensation

(up to $255,000 per employee). (up to $255,000 per employee). nonelective contributions.

(up to $255,000 per employee).

Limit on contributions per 100% of compensation, up to

participant

$51,000 per participant.

100% of compensation, up to $51,000 per participant.2

None

25% of compensation, up to

$51,000 per participant.3

Employee elective deferrals

No

Yes. Up to lesser of 100%

Yes. Up to lesser of 100%

No (except for SARSEPs

of compensation or $17,500

of compensation or $12,000

adopted before 1997).

($23,000 if age 50 or older).

($14,500 if age 50 or older).

Top-heavy rules

Yes

Yes

No

Yes

Nondiscrimination rules

Yes

Yes. Special rules apply to

No

No

apply?

employee deferrals.

Employee access to funds Limited by plan document. Income tax (and possibly 10% early distribution tax) applies.

Immediate. Income tax [and possibly 10% (25% if within first two years of participation) early distribution tax] applies.

Immediate. Income tax (and possibly 10% early distribution tax) applies.

Plan contribution subject to payroll / SE tax?

No

? Employer contributions for employees--No.

? Employee elective deferrals--Yes.

? Self-employed--Yes.

? Employee--No. ? Self-employed--Yes.

Date to start plan and make December 31, to establish plan. Return due date, including

employer contributions

extensions, for employer contributions.

Establish plan by October 1 of the year it is first effective. Make employer contributions by return due date, including extensions.

Return due date, including extensions.

Borrowing permitted?

Yes, if plan permits. To avoid income tax and possible early

No

No

distribution tax, must repay in five years (unless used to buy a

principal residence).

Permitted disparity

Yes

Yes

No

Yes, but only with nonmodel SEP.

Can allow a designated Roth

No

Yes

No

No

feature?

Funds in plan can be rolled Eligible retirement plan.4 over to

Eligible retirement plan.4

SIMPLE IRAs or, after two years, Eligible retirement plan.4 eligible retirement plan.4

Form 5500

Yes, unless one-

Yes, unless one-

No

No

requirement

participant/$100,000 exception participant/$100,000 exception

is met.

is met.

1 20% for self-employed individuals. 2 Catch-up elective deferrals made by employees age 50 or older are not taken into account when applying this limit. 3 For a salary reduction SEP (SARSEP) the contribution limits for 401(k) plans apply. Although existing SARSEPs can be maintained, new SARSEPs could not be established

after 1996. 4 Eligible retirement plans include: IRAs, qualified plans [including 401(k) plans], 403(a) annuity plans, 403(b) and 457(b) plans.

12-16 2013 Edition | Tax Planning for Individuals Quickfinder? Handbook

Other Taxes

Tab 13 Planning Topics

3.8% Net Investment Income Tax.......................... Page 13-1 Additional 0.9% Medicare Tax on Earnings........... Page 13-3 Alternative Minimum Tax........................................ Page 13-3 AMT Planning Considerations............................... Page 13-4 AMT for Individuals--Adjustments and

Preferences (2013).............................................. Page 13-7

3.8% Net Investment Income Tax

Starting in 2013, individuals are subject to a net investment income tax equal to 3.8% of the lesser of: [IRC ?1411(a)]

1) Net investment income (NII) or

2) The excess (if any) of modified adjusted gross income (MAGI) over the threshold amount.

Net Investment Income Tax MAGI Threshold

Filing Status MFJ, QW

Single, HOH MFS

Tax imposed when MAGI exceeds $250,000 200,000 125,000

Note: These amounts are not adjusted for inflation.

NObservation: Individuals will owe the tax only if

they have both (1) NII and (2) MAGI above the applicable threshold. Estates and trusts may also be subject to the tax if they have undistributed net investment income and adjusted gross income over certain amounts ($11,950 for 2013).

Note: The IRS has issued proposed regula-

tions under Section 1411. Taxpayers can rely on these proposed regulations until the final regulations are issued.

MAGI defined. MAGI is adjusted gross income (AGI) increased by any foreign earned income exclusion, net of the deductions and exclusions disallowed with respect to the foreign earned income.

Example: For 2013, Sam, a single taxpayer, has NII of $90,000 and wages of $180,000 (MAGI equals $270,000). Sam is subject to NII tax on $70,000, the amount by which his MAGI exceeds his $200,000 threshold amount, because that is less than his NII of $90,000. Sam's NII tax is $2,660 ($70,000 ? 3.8%).

Variation: Now assume Sam's NII is $90,000 and his wages are $210,000 (MAGI is $300,000). Because his MAGI exceeds his $200,000 threshold amount by $100,000, he is subject to NII tax on $90,000 (lesser of NII or the $100,000 excess MAGI). Sam's NII tax is $3,420 ($90,000 ? 3.8%).

Net Investment Income (NII)

General rule. NII is the sum of the following, reduced by allowable deductions that are properly allocable to them [IRC ?1411(c)(1); Prop. Reg. ?1.1411-4 and -5]:

1) Gross income from interest, dividends, annuities, royalties and rents, unless such items are derived in the ordinary course of a trade or business that is not a passive activity (under the Section 469 passive activity loss rules) with respect to the taxpayer (the ordinary course of a trade or business exception).

2) Other gross income derived from a trade or business that is a passive activity with respect to the taxpayer.

3) Net gain attributable to the disposition of property other than property held in a nonpassive trade or business.

NObservation: In most cases, interest, dividends, rents, roy-

alties and pass-through income from limited partnerships are included in NII.

Examples of gains included in NII include gains from the sale of stocks and securities, mutual fund capital gain distributions, gains from the sale of investment real estate and gains on residences that don't qualify for exclusion.

UCaution: A net loss on property dispositions does not reduce

NII. [Prop. Reg. ?1.1411-4(d)(2)]

Example: In 2013, Anna, a single taxpayer, realizes a $40,000 capital loss on the sale of P stock and a $10,000 capital gain on the sale of Q stock, resulting in a net capital loss of $30,000. Anna has no other capital gains or loss. She also receives wages of $300,000 and earns $5,000 of interest income. To figure her taxable income, Anna may use $3,000 of the net capital loss against other income. The remaining $27,000 is a capital loss carryover. To compute Anna's 2013 NII, her $10,000 gain on the Q stock is reduced, but not below zero, by her $40,000 loss on the P stock sale. Anna may not reduce NII by the $3,000 capital loss allowed for income tax purposes.

Qualified retirement plans. Distributions (including amounts deemed distributed, such as a Roth IRA conversion) from the following types of retirement plans are not included in NII: [IRC ?1411(c)(5); Prop. Reg. ?1.1411-8]

? Qualified pension, profit-sharing and stock bonus plans.

? 403(a) annuity plans.

? 403(b) annuities for employees of tax-exempt organizations or public schools.

? IRAs and Roth IRAs.

? 457(b) deferred compensation plans of state and local governments and tax-exempt organizations.

Special rule for traders in financial instruments. Income (including interest, dividends and capital gains) from the trade or business of trading financial instruments (such as stocks, bonds, options, forwards or futures contacts) or commodities is included in NII, regardless of whether the business is a passive activity [Prop. Reg. ?1.1411-5(a)(2)]. See Traders and the Net Investment Income (NII) Tax on Page 6-22 for details.

Working capital. Generally, income from the ordinary course of a trade or business (other than a financial instrument or commodity trading business) is not NII unless the trade or business is a passive activity. However, income, gains and losses from investment of working capital (for example, interest earned on a business's regular bank account or cash reserve account) are treated as not derived in the ordinary course of a trade or business (Prop. Reg. ?1.1411-6). So, such income is generally NII.

NObservation: Income from the ordinary course of a trade or

business (other than a financial instrument or commodities trading business) that is not a passive activity is not subject to the NII tax, whether the business is conducted as a sole proprietorship, a partnership, a limited liability company (LLC) or an S corporation. However, income from a trade or business that is a passive activity (however conducted) is subject to the tax.

Allowable deductions. To arrive at NII, gross investment income is reduced by deductions that are properly allocable to items of gross investment income, such as investment interest expense, investment advisory and brokerage fees, expenses related to rental and royalty income and state and local income taxes property allocable to items included in NII. [Prop. Reg. ?1.1411-4(f)]

2013 Edition | Tax Planning for Individuals Quickfinder? Handbook 13-1

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