We discuss the personal tax consequences related to Capital Loss deductions, Wash Rule, Foreign Tax Credit, Stock Options, Provisional Income, AMT, Rule 72(t), inheritance and gifts.
Capital Loss and Wash Rule: Capital Loss will first offset any Capital Gains, and if there is still a net Capital Loss, then it can offset up to $3K of Ordinary Income. Any excess Capital Loss can be carried forward indefinitely and the same calculations repeat for future years. However, one important caveat is that the position that resulted in a loss cannot be reacquired within 30 days of the sale. It is called the Wash Rule.
Foreign Tax Credit (FTC): Some countries have a DTAA (Double Taxation Avoidance Agreement) with US. This allows taxes paid to a foreign government on an income generated in that country to net against the Federal tax on that same income. Any excess foreign tax that remains after this netting can be carried over to future years. However, there is no reprieve from State taxes.
Non-Qualified Stock Options (NQSO): Companies offer stock options, which becomes vested over a few years, as part of employee compensation and retention plan. The stock price at the time of the NQSO issue is the Grant Price. After a NQSO vests, it works much like a Call option. The employee can exercise this option before it expires by acquiring the stock at the Grant Price, which can then be held or sold immediately. The stock price at the time of exercising is the Exercise Price. Ordinary Income tax is owed on the difference between Exercise Price and Grant Price. Capital Gains tax is owed on the difference between Sale Price and Exercise Price, which will be zero if the option is exercised and sold immediately.
Social Security Provisional Income: A Provisional Income is calculated to figure out what portion of Social Security benefits would be taxable. Half of your Social Security benefit is added to the Gross Income to compute the Provisional Income. 85% of your Social Security benefits will be taxable if the Provisional Income is >$34K/$44K for Single/MFJ (Married Filing Jointly).
Alternative Minimum Tax (AMT): AMT is a parallel tax structure to marginal tax. Tax owed is the greater of the two amounts. The first $70K/$109K of your income is exempt from AMT tax for Singles/MFJ with income <$500K/$1M. Most other deductions are not allowed for AMT. The AMT rate is a flat 26% for AMT Taxable Income <$192K for both Singles and MFJ, and 28% above this income threshold. With the TCJA law changes to AMT, individuals with income between $0.5-1M are those most affected by AMT, thus exposing far fewer taxpayers to AMT. A summary of changes from the TCJA law is discussed in our blog “Key Aspects of the TCJA Law.”
Rule 72(t) or SEPP (Substantially Equal Periodic Payments): This rule allows penalty free withdrawal from a Traditional IRA account prior to someone turning 59.5, provided the withdrawal is taken for at least 5 years or until the person turns 59.5, whichever is longer. Ordinary income tax is still owed on the entire withdrawal. The withdrawal amount is calculated using one of three methods, of which the Amortization method typically yields the highest value. This method calculates a fixed amount from amortizing the account balance over your life expectancy at 120% of the published Federal midterm rate. The typical annual withdrawal amount is ≈3-5% of Pre-Tax account value, depending on age.
Inheritance and gifts: Whether inheriting a property after someone’s death or receiving it as a gift during their life could make a big difference in the taxes owed. An Estate/Gift Tax is owed on the cost basis of the property and a Capital Gains tax is owed on the difference between the selling price and the cost basis. The cost basis for inheritance is the market value at the time of death, and for gifting it is the purchase price. The Estate/Gift Tax for most people will be zero because of the high lifetime exemption limit of $11.4M/$22.8M for the giving Single/Couple. For a more thorough discussion of this subject, please refer to “Estate and Gift Taxes.”
We specialize in tax-free retirement strategy and investments such as IUL, Annuity and LTC. Prefer a quick and complimentary consultation? Just email us at Karthik@FinCrafters.com