INVESTMENTS & TAXES

One of the greatest benefits of the tax code is the special tax rates that currently apply to gain recognized from the sale of capital assets held for more than a year (long-term).  The special tax rates apply to virtually all capital assets including land, improved real estate, your home, and business assets in excess of the accumulated depreciation previously deducted.  Beginning in 2008, these special rates, which apply to net long-term capital gains (LTCG)(1) and qualified dividends drop to zero percent to the extent that your regular tax rate is less than 25% and 15% for all other capital gains.  These rates, which apply only to non-corporate taxpayers, also apply for the alternative minimum tax and are available through 2010 barring any future tax law change. 

This zero tax rate provides an extraordinary opportunity for a taxpayer to cash in on certain gains and pay no tax.  This could be tax paradise for those who carefully plan their transactions for 2010.

The conventional strategy in the past was to offset as much of your gains as possible withlosses from selling other assets in your portfolio.  If you have an overall loss, then it is limited to $3,000 ($1,500 for married taxpayers filing separately), and any excess carries over to the next year.  Keep in mind that losses from the sale of business assets are generally separately allowed in full in the year of sale, and not mixed with the losses from the sale of other capital assets.  So with this change in the law, a new strategy emerges: it may be more appropriate to take gains to the extent they would be taxed at zero percent.

What this zero tax means to you is that there is no tax on your long-term capital gains to the extent that your regular tax rate is less than 25%.  Before you make plans to sell everything in 2010, remember that the gain itself adds to your income, impacts income-based limitations, and may possibly push you into a higher regular tax bracket, so it is a balancing act to take advantage of this zero rate.  Of course, you can also use losses to offset the gains, and contrary to past conventional strategy, you should only have enough losses to keep the gain within the zero tax rate. 

The zero tax rate applies to the amount of your taxable income below the 25% tax bracket.  For 2010, this “breakpoint” is the “top” of the 15% bracket and is:

• $34,000 (up from $33,950 in 2009) for single taxpayers and married taxpayers filing separate returns;

• $68,000 (up from $67,900 in 2009) for married taxpayers filing joint returns and surviving spouses; and

• $45,500 (up from $45,000 in 2009) for heads of households.

Thus, the amount of your adjusted net capital gain taxed at 0% is:

(1) The breakpoint amount for your filing status, minus

(2) Your “other” taxable income (taxable income reduced by adjusted net capital gain).

The following issues may also come into play when planning your capital gains and losses strategies: (1) Gains from the sale of inherited capital assets are automatically long-term;  (2) By election, long-term capital gains can be used to increase the amount of investment income when figuring the investment interest deduction, but then aren’t eligible for the lower capital gain tax rates; (3) Losses from selling personal-use capital assets, such as your home or auto, are not deductible, and (4) You may have short and/or long-term capital losses from a prior year to account for.  Also take into consideration how your state taxes capital gains; most do not have a 0% LTCG rate, and many do not have any special rates for capital gains.

Please give our office a call so that we can help you develop a strategy that will suit your unique situation.

(1)  Net capital gain is generally the excess of net long-term capital gains over net short-term capital losses, subject to certain netting rules.  However, the zero tax rate doesn't apply to collectibles gain or gain taxed on sales of certain small business stock, both taxed at a maximum rate of 28%, or to unrecaptured Sec. 1250 gain (depreciation) gain, which is taxed at a maximum rate of 25%. 

Generally, the only interest still deductible on the Schedule A is home mortgage interest, with one exception, investment interest. Investment interest can be interest you pay on your brokerage margin account, interest on investment property such as land, etc. However, this interest deduction is limited to "net investment income." In layman's terms, you can only deduct the interest expense to the extent you have investment income.

And to complicate matters further, the term "Net Investment Income" refers to investment income less any investment expenses. For example, you own vacant land and your annual property taxes on that land are $500. The property taxes are treated as investment expenses. You also have dividend and interest income of $1,200 for the year. Your net investment income is $700 (the $1,200 interest income less the $500 property tax expense). Therefore, you would be able to deduct $700 of investment interest for the year. If your investment interest exceeded the $700, the excess would carry over to the next year.

In a taxable year where there is a capital gain, the taxpayer can elect to treat any portion of that gain as investment income. If that election is made, then the taxpayer must treat the elected capital gains as ordinary income. This prevents a taxpayer from receiving the favorable capital rates and a deduction for investment interest based on the same net investment income.

The costs associated to your investments are deductible as a miscellaneous itemized deduction, subject to the 2% of gross income (AGI) limitation. Although they may seem trivial, it's still worthwhile to keep track of them as they can add up quickly. Combined with other allowable deductions, they can reduce your taxable income. Keep in mind, however, that investment expenses associated with tax-exempt income are not deductible. If the expenses are associated with both, you will need to prorate the expenses. The following are typical investment expenses you can deduct:

• Investment Management Fees - You can deduct payments to a broker or an investment manager to manage your stocks and other investments.
  
  
• Investment Publications & Periodicals - Books and periodicals related to investments and investing. Newspapers and other such publications of general application are not deductible.
  
  
• Investment Travel - Traveling costs related to your investments, such as trips to your broker or investment advisor and trips to look after investment property. The costs must be reasonable, and you must be prepared to prove the reasons for your travel in case of an inquiry by the IRS.
  
  
• Meals & Entertainment - One-half of the cost of your meals or entertaining costs in connection with your investments. For example, if you took your investment advisor to lunch to discuss investments.
  
  
• Legal Fees - Legal advice relating to your investments. If the legal services pertained to more than your investments, include only the portion of the fees that can be allocated to your investments.
  
  
• Professional Fees – As an example, you can deduct fees you paid to your accountant for tax advice relating to investment transactions.
  
  
• Safe Deposit Box Fees – Only to the extent that you store your investment documents.
  
  
• IRA or Keogh Custodian Fees – Provided you pay them directly to the custodian. If they paid from IRA or Keogh account fees, they are not deductible.
  
  
• Dividend Reinvestment – You can deduct service charges as part of a dividend reinvestment plan.
  
  
• Insurance Premiums – Cost of insurance to protect your investments.
  
  
• Home Computer Costs - If you use the computer to manage your investment activities. However, you generally must depreciate the computer using the straight-line method and allocate between investment and personal use.
  
  
• Software –The cost of software used to manage your investments. If the software has a life of over one year and the cost is $100 or more, you may need to depreciate the software.
  
  
• Office Rent – Rented property you use to manage your investments.
  
  
• Collection/Broker Fees – Paid to a broker, bank, trustee or agent to collect taxable bond and note interest or dividends. This doesn't include broker’s commissions on the purchase or sale of securities.
  
  
• Stockholder’s Meeting - Expenses of attending a stockholder’s meeting, even if you do not own stock in the company and the meeting would be useful towards making further investments. This deduction is limited to expenses associated with taxable income.
  
  
  

The year’s end has historically been a good time to plan tax savings by carefully structuring capital gains and losses. Let’s consider some possibilities.

If there are losses to date - As an example, suppose the stocks and other capital assets that were sold already during the year result in a net loss and that there are other investment assets still owned by the taxpayer that have appreciated in value. Consideration should be given to whether any of the appreciated assets should be sold (if their value has peaked), and thereby offset those gains with pre-existing losses.

Long-term capital losses offset long-term capital gains before they offset short-term capital gains. Similarly, short-term capital losses offset short-term capital gains before they offset long-term capital gains. Keep in mind that taxpayers may use up to $3,000 of total capital losses in excess of total capital gains as a deduction against ordinary income in computing adjusted gross income or AGI. Individuals are subject to tax at a rate as high as 35% on short-term capital gains and ordinary income. But long-term capital gains are generally taxed at a maximum rate of 15%.

All of this means that having long-term capital losses offset long-term capital gains should be avoided, since those losses will be more valuable if they are used to offset short-term capital gains or ordinary income. Avoiding this requires making sure that the long-term capital losses are not taken in the same year as the long-term capital gains. However, this is not just a tax issue; investment factors also need to be considered. It would not be wise to defer recognizing gain until the following year if there is too much risk that the property’s value will decline before it can be sold. Similarly, one wouldn't want to risk increasing a loss on property that is expected to continue declining in value by deferring its sale until the following year.

To the extent that taking long-term capital losses in a different year than long-term capital gains is consistent with good investment planning, a taxpayer should take steps to prevent those losses from offsetting those gains.

If there are no net capital losses so far for the year – If a taxpayer expects to realize such losses in the subsequent year well in excess of the $3,000 ceiling, consider shifting some of the sales and resulting excess losses into the current year. That way, the losses can offset current year gains, and up to $3,000 of any excess loss will become deductible against ordinary income in the subsequent year.

For the reasons outlined above, paper losses or gains on stocks may be worth recognizing this year in some situations. But if the stock is to be repurchased, it cannot be repurchased within a 61-day period (30 days before or 30 days after the date of sale) under the “wash sale” rules. If it is, the loss will not be recognized and will simply adjust the tax basis of the reacquired stock.

Careful handling of capital gains and losses can save substantial amounts of tax. Please contact this office to discuss year-end planning strategies that apply to your particular situation so as to maximize tax savings.

When an asset is sold, the owner owes capital gains on the profit. For these purposes, "profit" is the excess of the sales price over the owner's tax basis in the property. If the owner bought the property, his or her tax basis is generally equal to what he or she paid for it. Under the current rules, a beneficiary who inherits an asset, is generally allowed to use the asset's value on the date the deceased owner died as his or her tax basis in the asset. Because of this "step up" in basis, only the post-death appreciation is subject to income tax if the beneficiary decides to sell the asset. In addition, inherited assets are treated as if held long-term by the beneficiary, even if the assets would have received short-term treatment in the hands of the decedent.

Under the new legislation, this "step up" is greatly limited. For assets inherited during 2010, the beneficiary's basis will be the lesser of (1) the deceased's adjusted basis, or (2) the asset's value on the date of death. To help offset the additional income (or capital gain) tax beneficiaries will pay, the new legislation gives the estate of every US citizen and resident a $1.3 million "aggregate basis increase" to allocate among the deceased's assets. This increase can be allocated among assets in any way the deceased's personal representative decides, but no asset's basis can be increased above its date of death value. It also provides for an additional $3 million basis increase for the benefit of a surviving spouse.

Note: This basis increase cannot be applied to certain types of assets. These assets are generally ones that would have been taxable to the decedent such as retirement plan assets, Traditional IRA accounts, the taxable portion of uncollected installment notes, etc.

There are a number of ways that a little knowledge can be a risky thing when dealing with investments. Following is brief overview of some common mistakes made by investors.

• Investing based on a cold call from an unknown broker. This is generally always a mistake.
  
  
• Assuming you can exchange fund shares without triggering a gain. Many fund families provide fund exchange privileges, allowing you to freely exchange funds within the family of funds. However, the exchanges are taxable events and any gain or loss accounted for annually.
  
  
• Buying last year's hot investment. A previously rising star often has risen near its peak. Your late investment may have nowhere to go but down.
  
  
• Neglecting to periodically review your investments. If you like to buy and hold your investments, you may have a tendency to leave your investments alone for too long. Your allocations should be reviewed regularly.
  
  
• Having a belief that "fixed income" is also "fixed value." Just because the income rate is fixed for a bond, its value is not. In a time of rising interest rates, bond values can decrease.
  
  
• Equating high yields with high returns. Yield only deals with the income stream of an investment. Other factors, such as risk and volatility, can determine the underlying value of the investment. Both are necessary to achieve high returns.
  
  
• Presuming that all investment products sold by banks are insured. Many banks now offer more than their traditional products and non-insured products.
  
  
• Buying mutual fund shares late in the year. Almost all mutual funds make annual capital gain allocations late in the year, generally December. If you purchase right before these allocations, you'll receive significant taxable income even though you've only owned the fund for a small portion of the year.
  
  
• Writing checks on mutual fund accounts. Many mutual funds allow checks to be written against the account. Writing these checks can trigger a sale of fund shares that can be a taxable event.
  
  
• Forgetting about the "wash sale" rules. Re-purchasing a stock that you sold at a loss within thirty days of the previous sale, results in the loss becoming nondeductible for tax purposes.
  
  
• Relying on hot tips. Remember, if it sounds too good to be true, it probably isn't true.

If you can avoid the top ten investment blunders, you will save money on your taxes and perhaps even increase the returns on your investments. We realize that a mid-year review of your tax situation may not be at the top of your “to-do” list, but think of it this way: devoting a few minutes now could save you big bucks at tax time.

By following these tips, you can reduce your taxes for the year and even increase the after-tax return on some of your investments:

1. Anticipate distributions from declining funds - Since mutual funds are required to distribute capital gains to shareholders, you might receive a taxable distribution even though there was a decline in the share price of your fund this year. By preparing yourself and setting aside cash, you can avoid scrambling to pay taxes in April.

2. Purchase shares after the next scheduled distribution - Don’t buy a mutual fund shortly before a capital gains distribution since a portion of your investment will almost immediately be handed back to you. This will have you owing tax on the distribution with less money to reinvest.

3. Be prudent with “tax-exempt” investments - Although the income from “tax-exempt” investments is generally nontaxable, funds will sometimes throw off capital gains distributions. This happens when the fund managers sell bonds, which can produce a taxable capital gain, and then buy other bonds. This can aggravate fund investors who don’t expect to pay taxes on these types of investments.

In addition, if you want the income to be tax-exempt for state income tax purposes, you need to make sure the fund is invested in your resident state muni-bonds since most states treat as taxable muni-bond interest derived from other states. Another common mistake is failing to change funds when you move from one state to another.

If you are subject to the alternative minimum tax (AMT), be aware that interest from “private activity” muni-bonds is tax-exempt for regular tax purposes but not for AMT purposes.

4. Time your fund transfers wisely - Frequently, people sell one bond fund to buy another as a way of rebalancing their portfolio. However, for tax purposes, that represents a sale of a security and the purchase of another. Thus, you will need to account for the gain or loss from the fund sold on your tax return. This is generally an unpleasant surprise to those unaware of this rule, especially if there is significant gain to report on the sale. If there is a loss, selling it during the current year will allow you to utilize the loss now. However, if there is a gain, consider waiting until just after the first of the year so that you can defer the gain.

5. Contribute the maximum - If you maximize your retirement plan contributions, it will help maintain your current lifestyle years from now. In addition, it may also reduce this year’s taxable income.

6. Say “no” to tax-free investments in tax-sheltered plans - Instead of concentrating on annuities or municipal bonds, you’ll do better with high-yielding income and growth-oriented investments.

7. Sell a loser - There probably isn’t a stock market investor who isn’t holding a stock that is worth less now than when it was bought. Selling a loser in a taxable account can save you money and free up cash for investments with more potential. This is because the IRS allows investors to offset realized gains with realized losses. In addition, $3,000 in additional losses can be used to reduce your taxable income. Don’t sell for tax reasons alone, especially if you are confident that your dogs will turn into dream stocks. Just keep in mind that if a stock has dropped in price by 50%, it will need to gain 100% in order to break even.

8. Be aware of the limit on losses - If you are thinking of cashing in all your dogs, consider that losses are limited to offsetting realized gains and up to $3,000 in ordinary income. Although losses higher than this amount can be carried over for use in the future, they would be of no benefit to you this year.

9. Stay away from wash sales - If you would like to offset gains with losses, try and avoid “wash sales” since the IRS doesn’t allow you to recognize the loss on such sales. A wash sale occurs when a security is sold at a loss and then repurchased within 30 days before or after the date it was sold.

Don’t fret. One way you can realize losses and keep your portfolio balanced is to sell and buy back a security 31 days after the sale. Individuals who cannot wait for that period of time should purchase a similar security (not identical) to the one that was sold.

10. Check your cost basis when you sell - Although most people remember to include commissions on trades or mutual fund transaction fees when calculating cost basis, many fail to consider the dividend money that has automatically been reinvested, which results in taxpayers overpaying on taxes. Most commonly dividend reinvestment occurs with mutual funds but some companies also have dividend reinvestment plans for individual stockholders. Reinvested capital gains and dividends can add quite a bit to cost basis and make gains much smaller.

Review all your purchases when it comes time to sell. You will have a smaller taxable gain and a much better idea of your actual return on a fund.

As an investor, you want what’s best for your money. Be prepared and avoid the unnecessary headache at tax time. If you have specific concerns regarding your investments, please call our office so we can discuss them in detail.

Although there are a variety of sophisticated tax shelters available, our tax laws also afford special tax treatment to certain common types of investments. Used appropriately in conjunction with sound tax and investment planning, these special benefits may produce a higher after-tax return on your investment dollars.

Dividends: Through 2010, dividends received by an individual shareholder from domestic corporations (and certain foreign corporations) are treated as net capital gain for purposes of applying the capital gain tax rates. This means dividends are taxed at 15% for taxpayers whose marginal rate is above 15% and 0% in 2008 through 2010 (was 5% in 2007) for those in the 10% and 15% Tax Brackets. This net tax savings for each marginal tax bracket is illustrated below.

Tax Bracket	Qualified Dividend Rate	Net Tax Savings
10% 10% 15% 25% 28% 33% 35%	0% 5% 5% 15% 15% 15% 15%	10% 5% 10% 10% 13% 18% 20%

Even though dividends are taxed on the Schedule D, dividend income cannot be offset with capital losses. Dividends on stock held in a retirement plan or traditional IRA will not benefit from the new lower rates; distributions from these plans continue to be taxed at ordinary income rates.

Municipal Bonds: Although they generally pay a lower interest rate, their "after- tax" return can be higher than other similar investments such as corporate bonds, CDs, etc. Taxpayers in higher tax brackets and children subject to the "kiddie tax" frequently use this investment. If your state has income tax, you should note that most states will only allow the exclusion of interest on municipal bonds issued from that particular state. Municipal bonds can be purchased directly or investments can be made through a variety of municipal bond funds, many of which specialize in bonds from a specific state. Taxpayers drawing Social Security benefits should be reminded that even though municipal bond income may be tax-free, it is still used as income for purposes of determining the taxable portion of Social Security income.

Capital Gains: Gain from investments such as stocks, mutual funds, land, real estate, etc., are taxed at rates lower than an individual's regular tax rate if they are held over one year. Gains from such assets are generally taxed at 0% for tax years 2008 through 2010 (was 5% in 2007) if you are in the 15% tax bracket or below, or 15% if you are in the 25% or higher tax bracket.

Interest for Direct U.S. Government Obligations: This category includes U.S. Savings Bonds, T-Bills, H Bonds, etc. Interest earned on these obligations is taxable only for Federal purposes. Federal law prohibits states from taking a bite out of this income. Taxpayers that wish to reduce their state tax liability will greatly benefit from these investments. In addition, Savings Bond interest can be deferred until the bonds are cashed or reach maturity, providing a valuable tool for deferring income to some future tax year. Children, who are still dependents of their parents and have a lower standard deduction, can use the bonds to defer their income to a year when they get benefit of the full standard deduction, personal exemption, and lower tax rate. If that same child attends college, they may be able to offset the income with education credits.

Education Savings Bonds: Interest you receive from the redemption of U.S Series-EE savings bonds purchased after 1989 and after attaining the age of 24, held in your name or jointly with your spouse, may be excluded from income to the extent you pay qualified higher education expenses. The expenses must be for you, your spouse or a dependent and must have been paid during the same year the bonds were redeemed. The tax benefit has limited application since the benefit is phased out for taxpayers with higher incomes. For 2010, the phase out begins at $70,100 (up from $69,950 in 2009)for singles and $105,100 (up from $104,900 in 2009) for those filing jointly. The exclusion is completely phased out by the time singles reach $85,100 (up from $84,950 in 2009)  and $135,100 (up from $134,900 in 2009) for joint filers. If you are considering this strategy, keep in mind the income phase out is based on the year the bonds are redeemed and not the year they are purchased.

If we can assist you with the application of any of these strategies to your particular situation, please give us a call.

Most people don’t look at life insurance from an investment perspective. However, it is becoming a popular option among corporations and trusts because it provides the best after-tax returns compared to other investment vehicles.

The easiest way to see what life insurance can and cannot do is to make a simple comparison with other investment options. Make sure that the comparison is fair and that all costs, including tax effects, are analyzed on a year-to-year basis for both the insurance and the alternative investment. Don’t use investments that have completely different risk profiles; your comparison results will not be accurate.

If it is properly structured, life insurance can provide the following tax advantages:

• Your heirs will receive the death benefits tax-free.
  
  
• The cash values grow tax-deferred and any withdrawals are tax-free until the cumulative investment (in the contract) is recovered.
  
  
• A loan from the policy is not taxed as income.
  
  
• The death benefit will pay off any outstanding loan balances income tax-free at the time of death. The death proceeds can even be estate tax-free if the policy is owned by an Irrevocable Trust.

A life insurance program can be customized to meet your individual needs and objectives. If you are after the tax-advantaged cash value accumulation, you can minimize the life insurance benefit. In many cases though, the benefit is the most valuable feature since it immediately creates a capital sum at death that cannot be duplicated by any investment.

If you would like to discuss the tax benefits of a life insurance investment, please contact our office.

Gains from the sale of capital assets such as stocks and other securities held over a year are referred to as long-term capital gains, while those held for shorter periods are called short-term. Long-term gains enjoy special tax treatment while short-term gains are taxed as ordinary income. Taxpayers are currently enjoying lower capital gains rates through 2010. The rates below reflect the reduced rates for capital gains sales through 2010.

It is frequently asked if it is worth the risk holding a security long-term versus cashing in on short-term gain. Of course, no one has a crystal ball and can predict the future performance of a particular stock or the market in general, but we can provide some guidelines that will help you with your risk-reward analysis. The following chart illustrates the difference between short and long-term capital rates and the net savings based on a taxpayer's tax bracket. Keep in mind that your tax bracket is also a function of your total income including the capital gains. Therefore, the larger the gain, the greater the chance you will move into a higher tax bracket.

Tax Bracket	Short-Term Rate	Long-Term Rate	Net Long-Term Savings
10%	10%	5% (0% in 2008 - 2010)	5%
15%	15%	5% (0% in 2008 - 2010)	10%
25%	25%	15%	10%
28%	28%	15%	13%
33%	33%	15%	18%
35%	35%	15%	20%

As example, suppose you are in the 27% tax bracket and have a potential $10,000 capital gain. The tax for short-term gain is 27% or $2,700. On the other hand, if you held it over a year, the gain would be taxed at 20% or $2,000. Your savings would be $700.

Now it is up to you to decide whether the savings of $700 is worth the risk of holding the stock until it qualifies as long-term.

To take advantage of the long-term rates, you need to hold the asset longer than one year. The long-term rate depends on two things, your marginal tax rate and how long you have held the asset. The lower preferential capital gains rates do not apply to gains from collectibles (stamp collections, coins, art work, etc.) and gain attributable to depreciation recapture on sales of certain real estate.

• If your marginal rate is 15% or under—Your long-term capital gains rate will be 0% through 2010 (was 5% prior to 2008) for property held longer than one year.
  
• If your marginal rate is above 15%—Your long-term capital gains rate will be 15% for property held longer than one year.

If you own shares of the same stock purchased at different times and prices and can specifically identify those blocks of stock, it may be to your benefit to pick the block of shares you sell based on their cost and holding period. If you cannot specifically identify them, then the first-in first-out rule applies. Shareholders of mutual funds may choose to average the cost basis of shares bought at different times; for holding period purposes the mutual fund shares that are sold are considered to be the ones acquired first. When deciding whether to take a gain or hold for long-term rates, you should compare the savings associated with long-term rates to the financial risk of continuing to hold the investment.

These rates will continue through 2010. Taxpayers in the 15% or less tax brackets with unrealized long-term capital gains should develop strategies to take advantage of the “zero” tax rates through 2010, possibly cashing in on existing gains while avoiding any federal tax on the gains.

Owners of luxury homes with gains exceeding the $250,000/$500,000 exclusion limits and owners of second homes which do not qualify for the home sale gain exclusion will especially benefit from the these reduced rates.

There are almost an infinite variety of mutual funds available: specializing bonds, stocks, tax free instruments, foreign and domestic investments, growth stocks, income investments, specific industries and market segments, etc. Regardless of a specific fund's investment strategy, most will generally pay some amount of dividends each year and those dividends will have a significant impact on your annual tax bite.

• Ordinary Dividends – Generally, a dividend is a distribution paid by a corporation to its shareholders. Companies that are profitable will often distribute some of the corporation's profits in the form of dividends. A mutual fund will collect dividends from its investments and in turn pass a pro-rata share of these dividends on to the investors in the fund. In addition, if the fund has short-term capital gains from the sale of the funds' investments held for less than one year, each investor's pro-rata share of these short-term capital gains is added to ordinary dividends. This is the reason some funds, which invest solely in tax-free instruments, will still distribute taxable dividends even though the underlying portfolio is tax-free investments.
  
  
• Capital Gains Dividends – Represents the investor's pro-rata share of long-term capital gains from the sale of the fund's assets held over one year. These dividends receive the same special tax treatment as long-term capital gains and can be offset with any available capital losses from the sale of other capital assets. As with ordinary dividends, even though the fund may be invested in tax-free instruments, it may have long-term capital gains from the sale of some of its underlying portfolio.
  
  
• Foreign Taxes Withheld – By tax treaty with most nations, taxes are withheld at a specific percentage rate on investment earnings paid from the foreign country. Mutual funds will report both the amount of foreign dividends and the amount of taxes withheld. These numbers are used to compute the foreign tax credit.

As an investor, you have the option to have your dividends paid to you in cash or you may choose to reinvest your dividends and buy more shares of the fund that paid the dividends. But keep in mind, because you have the option to take the dividends in cash, the tax consequences of either form of dividend payment are the same: You are taxed on all dividends received. The exceptions to this tax rule are dividends held in tax-deferred investments, such as an IRA or 401(k).

When you reinvest the dividends, you are essentially purchasing additional shares of the fund with money on which you have already paid taxes. Therefore, you are adding to your basis in the fund. It is important to keep track of the reinvested dividends, so that when you sell your fund shares you can account for the additional purchases when figuring you gain or loss. For mutual funds purchased after 1996, many funds will track your tax basis in the fund for you. You should check with each fund to determine if they provide these basis-tracking services. For more specific information pertaining to your specific circumstances, please contact this office.

When a U.S. Savings Bond reaches original maturity, it automatically enters one or more extension periods (usually ten years). During these periods of extension, the bonds continue to earn interest. However, the extension periods for some bonds have expired, and they no longer earn interest. So if you or some member of your family have some old Series E Bonds lying about, it might be well worth your time to double check their maturity against the following chart.

Series	Issue Date	Final Maturity
E E EE H H HH	05/41 to 11/65 12/65 to 06/80 All Issues 06/52 to 01/57 02/57 to 12/79 All Issues	40 Years 30 Years 30 Years 29 Years, 8 Months 30 Years 20 Years

Keep in mind that U.S. Savings Bond interest is only taxable on the Federal return and exempt from state taxation, if applicable.

Through 2010, dividends received by an individual shareholder from domestic corporations (and certain foreign corporations) are treated as net capital gain for purposes of applying the capital gain tax rates. This means dividends are taxed at 15% for taxpayers whose marginal rate is above 15% and 0% through 2010 (was 5% prior to 2008) for those in the 10% and 15% Tax Brackets. Capital losses cannot offset the dividend income for purpose of the tax computation. To qualify for the lower rate, the stock on which the dividends are paid must be held for at least 60 days during the 120-day period that begins 60 days before the “ex-dividend” date. Dividends on stock held in a retirement plan or traditional IRA will not benefit from the new lower rates; distributions from these plans continue to be taxed at ordinary income rates.

Investors with investments both in and out of tax qualified accounts should consider putting more of the interest-generating portion of their portfolios, which would be subject to tax at ordinary income rates in any event, into their 401(k)s and IRAs, and more heavily weight the investments intended to generate preferential capital gain and dividend income in their taxable accounts.

Sell Loser Stocks To Offset Gains - With the roller coaster stock market this year, you may have a mix of winners and losers in your investment portfolio. If you have a net gain for the year, you should consider selling enough of the losers to offset the gain and produce a net loss of at least $3,000. This will erase your tax liability from the gains and allow you to deduct $3,000 against ordinary income. Don’t worry about having exactly a $3,000 net loss; any unused losses will carry over to future years. This strategy also works for capital gain dividends from mutual funds. Be careful not to repurchase any of the stocks you sold at a loss for 31 days. If you do, the loss will not be allowed because of the “wash sale” rules.

Check Your Mutual Funds Capital Gain Distribution Dates - Don’t end the year to find your mutual fund is down, but has still distributed large capital gain dividends that you must pay taxes on. If you sell before the fund's distribution date, you can avoid paying those capital gain distributions. If you plan on reacquiring the same fund, you will need to wait 31 days to avoid the wash sale rules. However, you can buy a similar fund of another fund family immediately.

Convert Your Traditional IRA To A Roth IRA - When you convert a Traditional IRA to a Roth IRA, you generally pay taxes on the value of the Traditional IRA converted. Therefore, the lower the value, the less it will cost to convert it to a Roth IRA. If you have one or more IRA accounts invested in stocks or mutual funds that have declined in value, this might be a good time to convert it to a Roth IRA.

It generally makes sense to convert to a Roth if you have many years to go before you plan on withdrawing your funds. Another reason to convert to a Roth is to pass on money to your heirs. Unlike a Regular IRA, there are no mandatory withdrawals and your heirs will not be liable for income taxes.

To convert, your annual income must be $100,000 or less for married couples and singles, and you must pay taxes on contributions and accumulated earnings in the same year. However, for 2010 the $100,000 has been lifted and the taxes can all be paid in 2010 or deferred until 2011 and 2012.  When making the decision to pay the conversion tax in 2010 or delay it to 2011 and 2012 beware that the tax rates will be higher in 2011 and 2012.

The conversion tax can be a very hefty bill, but if you need to take money out of your IRA to pay the taxes and you are under age 59 ½, you will be subject to a penalty on the amount withdrawn to pay the taxes.

It is recommended to call this office before making a conversion to avoid any unpleasant surprises. 

A frequent taxpayer question is whether it is better to invest for tax-free or taxable interest. Generally, taxable interest will provide the greater return, but this may not hold true after taking into account taxes on the income. Therefore, the question is really which provides the greater "after-tax" return. There are basically four types of interest that can be excluded from income, either on the Federal return or the state return and each has its own special considerations.

Municipal Bond Interest – Interest earned from general purpose obligations of states and local governments, which are issued to finance their operations, are generally tax-exempt for Federal purposes. However, the various states usually only exempt interest from bonds issued from the state itself and local governments within the state. Hence, there are two categories of municipal bonds, namely the tax-free Federal and state and the tax-free Federal only. Individuals can invest in municipal bonds by directly purchasing a bond or through mutual funds that invest in municipal bonds. Some mutual funds invest in bonds issued in a particular state only, providing residents of that state with income that is excludible on their state return.

For those drawing social security, you must also keep in mind that even though the income itself is tax-free, it is included in the computation used to determine how much of your social security income is taxable.

Private Activity Bond Interest – Some municipal bonds, classified as Private Activity Bonds, are tax-free for purposes of the regular tax, but may be taxable for purposes of the Alternative Minimum Tax (AMT). If a taxpayer is subject to the AMT, then the interest from these bonds may be taxable to some extent. The actual rate will depend upon your filing status and other AMT income, but could be as high as 28% plus any state tax, if applicable.

U.S. Government Bond Interest – By Federal law, direct obligations of the U.S. Government cannot be taxed by the states. This includes interest from U.S. Savings Bonds, U.S. Treasury bills, notes, bonds, or other obligations of the United States. Interest earned from the Federal National Mortgage Association (Fannie Mae), Government National Mortgage Association (Ginnie Mae) and the Federal Home Loan Mortgage (FHLMC) Corporations are not direct obligations of the U.S. Government, and therefore, are not excludable from state taxation unless specifically allowed by state law that is generally not the case. If you reside in a state with no state income tax, U.S. Government Bond Interest provides no tax benefit.

If you do have a state tax and the investment is tax-free in your state, then it also makes a difference whether or not you itemize your deductions on your Federal return. Since having state tax-free income reduces your state tax and is deductible if you itemize, the reduced state tax in effect reduces your itemized deductions and increases your Federal tax.

Use this worksheet to determine the tax-exempt interest equivalents for your particular tax bracket, state tax (if applicable), and type of tax-exempt in investment. Enter all rates in decimal format. For example, 5.75% would be entered as .0575. Carry all calculated values to at least 4 places after the decimal.

Taxpayer Information: 1. Enter the taxable interest rate you wish to compare 2. Enter your Federal tax bracket 3. Enter your State tax bracket (Enter zero if your state has no state income tax) 4. If you itemize your Federal deductions Multiply line 2 times line 3 and enter the result here Tax-Free Equivalent - State AND Federal Tax-Free: 5. Line 2 plus line 3 minus line 4 6. Multiply line 5 times line 1 7. Tax-Free Equivalent (line 1 less line 6) Tax-Free Equivalent - Federal ONLY Tax-Free: 8. Multiply line 2 times line 1 9. Tax-Free Equivalent (line 1 less line 8) Tax-Free Equivalent - State ONLY Tax-Free: 10. Line 3 minus line 4 11. Multiply line 10 times line 1 12. Tax-Free Equivalent (line 1 less line 11)

0.____ 0.____ 0.____ 0.____ 0.____ 0.____ 0.____ 0.____ 0.____

0.____     0.____ 0.____ 0.____

 

Tax law allows you as an investor to offset capital gains with capital losses, and if the losses exceed the gains, you can deduct losses up to a maximum of $3,000 ($1,500 if filing married separate) for the tax year. For this reason, investors frequently review their securities portfolio at year's end searching for stocks and other securities whose sales will result in a capital loss. This allows them to minimize their gains or maximize their losses for the year.

The wash sale rules could spoil this planning strategy, however. Under these rules, a loss is disallowed if the security sold at a loss is repurchased within 30 days. A loss will also be disallowed if the investor buys the same security 30 days before the sale. The IRS definition of a wash sale is: "A sale that occurs when you sell or otherwise dispose of stock or securities at a loss, and within 30 days before or after the sale or disposition, you buy substantially identical stock or securities."

This rule can affect the investor who may actually wish to hold a particular security, only sells to take advantage of a loss position intending to buy the same security back at a later date. It can also affect "day traders" who buy and sell the same security frequently during the year.

When wash sales do occur, the tax basis of the replacement stock is increased by the amount of the loss that was disallowed, so when you sell the replacement stock you will be able to take advantage of losses incurred in the wash sale.

CAUTION: The IRS recently ruled that where a taxpayer sells securities at a loss and purchases substantially identical securities in the taxpayer’s IRA or Roth IRA, that the wash sale rules apply to such a sale and the loss is disallowed.  The basis of the securities in the IRA is increased by the amount of the loss (but the basis of the IRA itself is not increased).