In clear and simple language, "Capital Gains, Minimal Taxes" explains most investment-tax-related topics investors need to understand, ranging from calculating your basis on stocks and mutual funds to maximizing the allowed tax deduction for a capital loss.
Because taxes consume a substantial chunk of ordinary income, many knowledgeable investors wish to maximize their investment in things which are taxed at the more favorable capital gain tax rates (currently 10% for investors within the 15% income tax bracket and 20% for investors whose entire income falls above the 15% income tax bracket).
Thomas begins by working several examples to show investors how to calculate their tax burden given their tax bracket and the amount of their short-term and long-term capital gains and losses from stocks and mutual funds. Thomas devotes a chapter each to the special rules which apply to the taxation of individual stocks and mutual funds.
Thomas shows that, sometimes, we can lower the capital gains tax paid by identifying the specific shares of individual stock being sold. For example, suppose we buy 100 shares in Company XYZ at $10 per share on July 1, 1999. We buy 100 more shares of XYZ at $20 per share on July 9, 2000. We then sell 100 shares of XYZ on July 19, 2001 for $30 per share.
Unless we specified otherwise at the time of the sale, Thomas tells us that from a tax standpoint the shares sold will be treated on the first-in-first-out basis (FIFO). We will be taxed on a net long-term capital gain of $20 per share. However, had we identified the shares sold as those purchased on July 9, 2000, we would be taxed on only a net capital gain of $10 per share. Thomas explains the two things that must happen to ensure that the identification of shares will be deemed valid by the IRS.
Calculating your adjusted basis in a stock or mutual fund and properly determining your holding period is covered in detail with numerous examples. He also explains how mutual fund dividends and capital gain distributions are taxed.
Thomas gives us his opinion of the Alternative Minimum Tax (AMT). Thomas writes: "The basic idea behind the alternative minimum tax is a good one: people with very high levels of income shouldn't be able to completely avoid paying income tax while the rest of us pony up each year. The AMT is a poor reflection of that idea, however. Many high-income individuals escape its reach-and every year it ensnares more and more people who were never intended to be affected."
Employees who had massive gains followed by equally massive losses on their employee stock options are one example of people who would have benefited by knowing the tax laws better. As you've probably read in the news, some individuals have gone from being wealthy to not having enough total wealth to pay their current tax liability, compliments of the AMT not playing nicely with employee stock options.
While Thomas briefly touches upon the topic of employee stock options in Capital Gains, Minimal Taxes, he doesn't go into detail. Another bestselling book by Thomas, "Consider Your Options: Get the Most from Your Equity Compensation," addresses employee stock options.
Thomas writes, "It's worth noting that you can end up with a gain that's greater than the amount of money you realize in a sale. That's one reason to plan carefully when you use debt to acquire investment assets. You may have to come up with money from other sources to pay the tax on your gain ...There's only one thing worse than having to report gain that's greater than your net sale proceeds, and that's having the tax itself be greater than the net sale proceeds."
Other topics discussed in "Capital Gains, Minimal Taxes" include:
-- Tax rules for gifts
-- Dividend reinvestment plans
-- Wash Sale Rule
-- Capital loss carryovers
-- Taxation of stock acquired from a spouse
-- Separation, divorce, and who gets custody of the basis
-- Stock dividends and splits
-- Taxation of mergers and spin-offs
-- Stock that has become worthless
-- Qualified small business stock
-- Planning for lower taxes
-- Making estimated tax payments
-- Custodial accounts for minors and special issues affecting child investors
-- Tax deductibility of Investment Expenses and Investment Interest
Throughout "Capital Gains, Minimal Taxes," Thomas gives us tips for not inadvertently losing valuable tax deductions. And, he shows us ways investors could potentially save thousands of dollars through a little tax planning.
For example, upon inheriting stock, we learn that the basis of the stock is changed to its fair market value on the date of the giver's death. So, by holding a greatly appreciated stock and passing it on to heirs, we can eliminate taxes on all the capital gain that occurs between the original purchase and the end of our lives. While stock basis can "step up," Thomas explains that the reverse can also occur.
Suppose we had originally purchased stock for $20,000, but today the stock is only worth $2,000. If we die and the stock is inherited, the basis steps down to its market value of $2,000. No one gets to take the tax deduction for the $18,000 capital loss. Thomas notes that investors tend to sell their winners too early and their losers too late.
I consider myself a fairly knowledgeable investor, and I learned a great deal about the taxation of investments by reading "Capital Gains, Minimal Taxes." This book belongs in every serious investor's library. Remember, each dollar saved in taxes adds directly to your wealth. Peter Hupalo
