Don't Mess With Taxes

For folks with money in the stock market, the coronavirus' effect on their holdings is more terrifying than Michael Myers, the persistent slasher of "Halloween" horror movie fame.

I confess. I've been glued to cable TV financial channels this week. They're showing, for owners of stocks, a real-life horror movie. The evil and infectious COVID-19 monster is maniacally slashing investment gains.

Who or what can show up (soon, please!) to stop this crazed killer of our planned comfortable retirement?

OK, I might be taking this sequel — and that's what it is; market corrections and recessions have happened before — a bit hard. That's because now I am much closer to retirement.

When Black Monday in 1987 and the recent Great Recession's decade of decline happened, I knew I had many years to recover. And my holdings did.

My one current investing consolation is that the hubby and I took my year-end tax moves advice and rebalanced our portfolios appropriately for our ages. I confess. I was in financial vehicles that were a bit more adventurous than advisable for a person of my age. And yes, for a while I rued and stewed about giving up some of the early 2020 market heady increases.

Now, however, I've glad went more cautious and are just hunkering down. Freaking a bit, but mostly hunkering.

A lot of folks, however, obviously are bailing on the markets. That's their choice and it could be yours, too, if this slide turns into a full-fledged stock avalanche.

In that case, I wish you and your financial strategy well. And if you have or are considering selling assets, I also want to share a bit about the associated tax matters.

Capital gains (or losses) considerations: Yep, I'm talking capital gains and, likely in this market atmosphere, capital losses.

A capital gain is what you get when an asset you hold over time increases in value.

For example, you bought 100 shares of a stock when it was worth $20 a share, resulting in a total asset holding worth $2,000. You sell all that stock after it goes up to $30 a share, giving you $3,000 or a $1,000 gain over your $2,000 purchase.

If, however, you decide to just bail and sell the stock that's now worth only $10 a share ($1,000 total), you'd sustain a loss of $1,000 — your $1,000 sales minus your $2,000 initial purchase. That's a capital loss.

Capital gains tax timing: Let's be optimistic and say you sold your asset for more than you paid. Yes, this could happen, even with this week's drops, if you bought a stock many, many years ago when it was very cheap.

That's an example of how in investing and taxes, like in comedy and life, timing is everything.

If you sold that stock within a year of buying it, these sales are classified as short-term capital gains. In these cases, you'll owe ordinary tax — that's the tax rate that applies to our basic earned income, ranging from 10 percent to 37 percent — on your $1,000 profit from the earlier example.

But if you'd held that stock for more than a year, then the tax code and Internal Revenue Service consider that long-term capital gain. The taxes on long-term gains are 15 percent or 20 percent, typically lower than what you'd pay on your ordinary income or short-term capital gains.

The long-term capital gains tax rates essentially are a tax reward to folks who are willing to take longer term risks with their investments.

Income's effect on capital gains taxes: The precise capital gains tax rate you'll pay depends not only on how long you own an asset, but also on your income.

The higher 20 percent rate for long-term gains is paid by wealthier investors. Really rich investors, however, also face the Net Investment Income Tax (NIIT), which is an additional 3.8 tax created as part of the Affordable Care Act. The NIIT pushes the top long-term capital gains tax rate to 23.8 percent.

At the other end of the earnings scale, lower-income taxpayers tend to pay the 15 percent capital gains rate.

And some could collect gains tax-free. A 0 percent tax on capital gains is available to single investors making $40,000 or less (double that for joint filers) in 2020.

The Tax Cuts and Jobs Act (TCJA) made a lot of changes to tax rates, but it kept the three that apply to long-term capital gains. However, it did establish separate income brackets, which are adjusted annually for inflation, for these taxes.

The table below shows the income brackets by filing status to which any long-term capital gains you realize in 2020 would apply when you file your tax return next year:

And if you made some portfolio moves in 2019, those will be reported on your Form 1040 you'll file by this coming April 15. The 2019 tax year long-term capital gains rates and income brackets that apply to current taxes are:

And yes, there are other capital gains tax rates for other holdings, like collectibles. For this post's purposes, though, the focus is on the capital gains taxes for basic asset sales.

Selling caveats: OK, you've taken some antacids and decided to tough out the current market dive. Or you've had enough and are putting in the sale call now.

Here are a few more things to think about before you do either.

First, if you're still watching and leaning toward staying with your investments, take some comfort that right now you really haven't lost anything other than maybe some sleep.

Nothing happens, not a single thing, financially or tax-wise until you actually sell your assets. You can be watching the plunging markets in horror, but unless you've actually sold the asset, those losses are just paper losses. You don't suffer losses or collect gains and pay any associated tax until you literally realize them by selling, for better or worse, your holdings.

Basis basics: Second, your gains probably won't be as clear cut as this post's example. To get to your taxable profit (or loss), you do subtract asset's basis from the price you got upon its sale.

But your cost basis typically is more than just what you paid for the asset, which was what I used in my simplified, for-illustration-purposes-only example. In addition to your purchase price, an asset's basis also includes things like commissions, fees, any previously taxed reinvested earnings and in some cases deprecation of the asset over time.

Losses can pay off, too: Third, if you sold at a loss, you still might be able to take tax advantage of this transaction. You use those loss amounts to offset any capital gains you might have. This includes not just total asset sale profits, but also other gains you might have in the tax year, such as capital gains distributions that usually show up in stock funds at the end of the year even if the overall value of the fund drops.

Many sellers this week probably incurred capital losses.

And if your capital losses are larger than your gains, you can use up to $3,000 of that amount to reduce your ordinary income. Any more than three grand in losses can be carried forward to future tax years to offset, again at the maximum $3,000 per tax year, capital gains then.

Finally, if your stock holdings are in a retirement account, either a regular 401(k) or traditional IRA, the capital gains tax rates don't apply to these tax-deferred financial instruments.

Although your money is in stocks, the tax law requires that when you do take out the money — and eventually you will be required to do that at age 72 under the recently revised required minimum distribution (RMD) rules — those withdrawals will be taxed at your ordinary income rates. Again, the taxes here could be as high as 37 percent.

Yes, there's a lot tax-wise to think about when it comes to your portfolio. But you need to take taxes into account even, or perhaps especially, when outside circumstances like coronavirus are forcing your investment decisions.

And if you're young and adventurous, take heart. Your investments will recover. Some market analysts say the current downtown offers a great buying opportunity.

You also might find these items of interest:

• Timing differences in Vanguard's issuance of 1099s
• Cryptocurrency tax compliance effort a success for asset owners and IRS
• Senators duke it out over capital gains inflation in letters to Treasury Department

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