Question

"New Tax Codes and Stock"

• Calvin, a client of yours since you opened your practice, has over the past few years become very intrigued with investing in the stock market. He has interest bearing securities and dividend paying stocks. He also owns U.S. Securities. He is considering selling $400,000 in stocks. He doesn’t know if he should sell additional stock for a loss to help offset the stock sale of $400,000. Calvin called you to ask what tax consequences the interest and dividends will have along with the stock sale. What tax advice would you offer to Calvin in planning for this situation?

Comment on this

Interest and dividends have tax consequences, as well as a stock sale. Selling stock will help offset the stock sale of $400,000. The ordinary dividends and interest income from Calvin's investment of $400,000 will be taxed as ordinary income. The qualified dividends, the capital gains, and/or the capital losses from the stock sale will be taxed at the capital gains rate. Selling the additional stock will help offset the loss, because selling stock will increase his AGI. Realizing a loss will lessen the tax burden on Calvin.

Answer 1

Any amount of ordinary dividends and interest income received by Calvin will get taxed as ordinary income. On the other hand, qualified dividends and any value of capital gain realized from sale of securities will be subject to capital gains tax rate as per the applicable rules. It is important to note that a lower capital gain tax rate may be applicable on qualified dividends (if certain requirements are met).

The amount of capital gain realized from sale of capital stock will result in an increase in the value of adjusted gross income, thereby, resulting in higher tax liability for Calvin. Sale of additional capital stock at a loss will lower the the taxable income, which in turn, would lower the overall tax liability. However, selling additional capital stock at a loss to reduce tax liability is not advisable, because, if Calvin continues to hold these investments, he might be able to generate additional dividend income in the coming years. Further, there is a possibility that the value of stock may increase in future providing higher returns to Calvin. Therefore, Calvin should try to estimate the potential earnings he will be able to derive because of his investment and compare it with the tax benefit that he can realize today by selling the stock at a loss. Calvin can look for other tax saving avenues in order to reduce the tax burden if the possible returns from holding the investment exceed the tax benefit (that he may get by selling the stock today at a loss). Selling of stock at a loss is advisable only if Calvin is sure that he will not be able to generate any amount of additional income (in future) as a result of holding the stock or the amount of potential earnings will turn out to be lesser when compared with the tax benefit today.