Investing, in its bare bones form, is all about letting the money you have make more money for you. This holds true for stock market investment too. Investing in the stock market allows you to ride the wave of rising stock prices and you can earn windfall returns when the stock market performs favorably. On the flip side, you can also incur significant losses in case of a stock market decline. Fortunately, Uncle Sam can help you in recovering some of the losses incurred due to a downturn in the stock market.
You should know that the success of corporate America can be largely attributed to individual investors. That's why the federal government offers various tax benefits for the investors. One such incentive is in the form of allowing stock investors to offset the losses against the taxable amount.
The IRS allows recognition of gain or loss on stocks only when the stocks are sold. Stock market losses are first offset against the gains. In case of any extra losses, it can be deducted against income of up to $3,000, or $1,500 in case of married filing separately. Put simply, what this means is that stock markets losses can help you lower your tax liability.
The maximum marginal tax rate on ordinary income is about 39.6%. This is applicable for couples with income tax of above $464,850, or $413,200 for single taxpayers. If you are subject to net investment income tax (NIIT), the tax rate can be up to 43.4%.
You can carry forward the losses that are in excess of the limit to the next year, to lower ordinary income or capital gains amount. This will work in your favor, allowing you to obtain greater tax savings.
Let’s take an example to better illustrate how offsetting stock losses can help in reducing your tax liability. Suppose that you are in a 27% ordinary income tax bracket and earned a net long term gain on stocks amounting to $2,000. In this case, the tax due from the gain will be calculated at 20% capital gains tax rate, resulting in a tax liability of $400.
However, if you had incurred a long term capital loss of $2,000, the tax savings would be calculated using the 27% ordinary income tax rate. In this case, the total amount of tax reduction will be $540, which represents savings of $140.
You can report stock market losses by mentioning it on line 13 in Schedule D of Form 1040. Here, we will outline the steps that you will help you in reporting losses to the IRS.
First, you must calculate the amount of loss incurred on sale of the stock. The gain or loss amount that you report to the IRS is determined by deducting total investment amount. This includes transaction costs and broker fees from the net proceeds from sale of stocks. Transaction fees are excluded. Any loss that you incur on sale of stocks is tax deductible.
After you have determined the net loss on stocks, you must use Part I of Form 1040, Schedule D to arrive at the loss amount on stocks that are held for less than one year. Use Part II of the same form in case of loss on stocks held for more than one year.
Enter name of the stock that you sold on column A, the date you purchased the stock in Column B, and the year it was sold in Column C. You should enter proceeds of the sale in column D and costs involved in selling the stocks including stock broker fees and commission in Column E. Next, deduct the net amount entered in Column E from that of Column D, and write down the figure in Column F.
Enter the amount entered in Schedule D of Form 1040 on line 13, and deduct the stock market losses from the taxable income.
Remember that you are allowed to deduct $3,000 or less in case you are married and filing jointly. In case you are single or married but filing separately, you can deduct $1,500 or less in stock losses. Also, you should remember that you are allowed to offset the losses incurred due to sale of the stocks. The IRS does not allow offsetting of losses incurred due to decrease in value of the underlying stocks.
Using stock losses to reduce tax liability can be an effective strategy for purging low value stocks. A tax loss harvesting strategy helps in boosting overall portfolio gains. It can help you get rid of depreciated stocks that have no future growth prospects or those that no longer fit your portfolio strategy.
Active traders can benefit the most from the tax loss harvesting strategy. In addition, this strategy will be effective for investors who rebalance their portfolio every year to ensure that it is aligned to their long term financial goals. Rebalancing of the portfolio refer to changing the mix of investment i.e. bonds, stocks and short term investment. Whatever the portfolio goals, a tax harvesting strategy can help in rebalancing your portfolio and bringing it back in line with your original investment goals.
That said, you should not undermine your investment strategy for solely tax purposes. It's advisable that you carefully research your cost basis and determine the savings before using the tax harvesting strategy.
A professional tax preparer can help you in effectively using this tax strategy to optimize your portfolio. You can contact experienced tax experts and accountants by clicking the link below. Our experts can provide professional advice and tips to ensure that you gain maximum tax benefits that are allowed by the IRS. We will help you in navigating through the complex tax rules and regulations, simplifying the whole process for you.
Falisha Griffin