The IRS Provides Advice For Investors With Losses
Overall, this year has been a mixed bag for shareholders. Descending market averages have plagued investors for the greater part of 2002. However, for the past eight weeks, the leading stock market averages have posted gains. Whether this eight-week trend is a sign of a long-term upswing or merely a temporary rise in an otherwise downward trend, is the subject of much current debate.
Operating in this sea of uncertainty, your clients may be considering (or may have already done) some portfolio pruning before Dec. 31–that is, selling stocks to eliminate those that appear to have poor future prospects or simply to rebalance portfolios.
IRS guidance released earlier this year provides tips for investors with losses, including how to properly claim capital losses and how to deal with worthless stock.
Capital Losses. In general, realized capital losses are first offset against realized capital gains. Then, any excess losses can be deducted against ordinary income up to $3,000 ($1,500 if married filing separately) on line 13 of Form 1040. (There was legislation introduced in 2002 to raise this limit to $8,250, but it got held up in partisan conflict.) Losses in excess of that limit can be carried forward to later years to reduce capital gains or ordinary income until the balance of these losses is used up.
Capital gains and losses on the sale or trade of investments are classified as either short-term (if the property has been held for one year or less), or long-term (if held for more than one year); such losses should be claimed on Schedule D of Form 1040. Although these two categories are subject to different rates in the event of a net gain, a net capital loss resulting from either category is directly deductible from ordinary income up to the annual limit.
The IRS points out that this often works out to the taxpayers advantage, yielding greater relief for losses than if an applicable long-term capital gains tax rate were used. Generally, capital gains rates are lower than the rates on ordinary income. For example, if a taxpayer in the 27% bracket had a net long-term capital gain on stocks of $2,000, the tax due from the gain would be calculated at the 20% capital gains rates for a total of $400. On the other hand, if the same taxpayer has a net long-term capital loss of $2,000, the corresponding tax savings would be calculated at the individuals ordinary rate of 27%, for a $540 reduction in taxes. [News Release IR-2002-127 (11-25-02)]
Worthless Stock. This year the IRS provided investors with a detailed how-to manual for claiming deductions for worthless stock.
General. Worthless stock losses must be: (1) evidenced by closed and completed transactions; (2) fixed by identifiable events; (3) bona fide losses; and (4) actually sustained during the taxable period.
