Strategy and timing are as important as skill in investing, particularly with regard to taxes. There are a number of tax-smart investment strategies you may want to consider, especially in light of recent legislation that lowered the tax rate on dividends and capital gains.
Dividends
Dividend income received by an individual shareholder from a domestic or qualified foreign company is taxed at a top rate of 15 percent and at just 5 percent for taxpayers in the 10 percent and 15 percent tax brackets. For taxpayers in the 10- and 15-percent brackets, the 5-percent rate will apply through 2007 and will fall to zero for 2008 through 2010.
But be careful. To receive a dividend that qualifies for the lower tax rate, you must buy the stock at least one day before the ex-dividend date and hold that stock for at least 60 more days. The ex-dividend date is the last date on which shareholders of record are entitled to receive the upcoming dividend. Essentially, what this means is that if you owned shares for only a short time around the ex-dividend date, your dividend income will be taxed as ordinary income and not eligible for the 15 percent rate.
Here's another caveat: not all income payments that are called dividends are qualified dividends in the true "taxed at 15 percent" sense. For example, the money you earn on savings accounts, certificates of deposit and money market funds is sometimes referred to as dividends, but is really interest and is taxed as ordinary income.
You might be wondering whether you should invest more heavily in stocks that pay high dividends. The answer is yes - and no. Surely, stocks that pay a high dividend are more attractive now, but that doesn't mean they are going to perform better than stocks that don't pay dividends. And here's something else to consider. If you're holding stocks that don't pay dividends, there is no tax bill until you sell those stocks at a gain. In contrast, the tax on dividends applies in the year the dividend is paid.
In any case, you should never let tax considerations drive your investment decisions. Be sure that your overall financial objectives guide your investment strategies.
Capital gains tax
The maximum tax rate on net long-term capital gains is also 15 percent. If you're in the 10 percent or 15 percent tax bracket, your net long-term capital gains will be taxed at only 5 percent. The 5-percent rate will fall to zero for 2008 through 2010. Keep in mind that to qualify for long-term tax treatment, an asset must be held for more than one year before it is sold. The net long-term capital gains tax rate from the sales of collectibles remains at 28 percent.
Offset capital gains with losses
When it comes to investment decisions, knowing when to make a move is critical.
This is an excellent time of year to review your portfolio and determine whether you should initiate any investment moves. You may have some gains to report on your 2007 tax return. If that's the case, consider whether it makes good investment sense to take some losses to offset capital gains. Net capital losses are fully deductible against capital gains. If your capital losses exceed your capital gains, you can deduct up to $3,000 in net capital losses against ordinary income. That figure is $1,500 if married filing separately. Excess losses may be carried forward to subsequent years.
Keep in mind that an investment sold at a loss need not be gone forever. If you believe it was a good long-term investment, you can buy it back. Just be sure to wait 31 days, otherwise you'll get caught up in the wash sale rule. This rule disallows losses on securities sold if substantially identical securities are bought within 30 days before or after the loss sale.
Article provided by the Massachusetts Society of Certified Public Accountants.
