Last-Minute Tax Aid: Tracy Byrnes, Martin Nissenbaum Chat on Yahoo!

Tracy Byrnes and Martin Nissenbaum chatted on Yahoo!, Thursday, Oct. 12 at 5:00 p.m. EDT.

tracy_tsc2000: Hi everyone! Thanks for coming! And a big thanks to Martin for stopping by to help us out!

martin_tsc: Hi everyone. Well Oct. 16 is the last day to file timely, so this is your last chance to shoot those questions in before Monday!

absenceofmalice asks: How can you avoid paying capital gains taxes when you sell stock options?

martin_tsc: I assume you mean an investment option. There really is none, other than exercising the option and holding the stock.

tracy_tsc2000: But when you do sell, what's your holding period? In other words, when is the gain calculated from?

martin_tsc: Your holding period would start from the date of exercise, unless you have a warrant instead of an option. If you do a cashless exercise of a warrant, your holding period would include the period you held the warrant.

Davebudk asks: What is a Roth IRA, and are they the best type of savings account to invest in?

martin_tsc: A Roth IRA is an IRA where the contribution is nondeductible but all distributions are tax free, including income earned in the IRA.

tracy_tsc2000: As long as you hold the account open for 5 years and you wait till you're 59 1/2 to withdraw the $$$.

martin_tsc: If you have a Roth IRA, and you invest in fixed income as an overall portfolio strategy then that's where those assets should be since the income would otherwise be ordinary. Otherwise, just invest for the biggest return possible; there are no required distributions from a Roth IRA.

tracy_tsc2000: Yeah, any assets that produce income should go in your tax-deferred accounts, like the Roth.

zooey_franny asks: Do you think 401k investments should be conservative or risky?

martin_tsc: I think the answer is similar to the Roth IRA issue. Since a 401k is tax deferred, you generally want to shelter income that's taxed at a higher rate.

tracy_tsc2000: That's where your mutual funds with high turnover should go.

martin_tsc: Like fixed income: The issue of risky or conservative should be based on your entire portfolio analysis and not just on your 401k.

tracy_tsc2000: So you can put off paying tax on any distributions.

martin_tsc: But don't be too risk averse everywhere or you'll wind up with a lot less than you could have (ignoring, of course, today's market).

tracy_tsc2000: Yes, let's ignore today's market.

martin_tsc: Let's.

brunoa99 asks: So if I am thinking of getting into daytrading, what should I be looking for as far as taxes go?

martin_tsc: The key issue with daytraders is whether they are considered to be in a trade or business or are just investors. To be a trader your activity would have to be substantial and you must be seeking short-term profits rather than appreciation.

If you are a trader a number of beneficial rules apply. Your interest expense is deductible above the line and so are your expenses, but you still get capital gains treatment for your trades.

brunoa99 asks: Thanks, what is the difference?

martin_tsc: If you're an investor your expenses would be misc. deductions subject to a 2% of AGI disallowance and your interest will only be deductible to the extent of investment income.

tracy_tsc2000: Investors trade for the long term, traders are in it for the short term on the profit front, that is.

debastar asks: I'm only 23 and just received money from the sale of a house; what is the best way for me to invest to receive the best tax break come tax season?

martin_tsc: I assume that the gain from the sale is tax-free. (Usually up to 250k of gain would be.) The income from your investments is taxed, based on what you've invested in. At your age a tax-efficient investment strategy might include the purchase of an index mutual fund without current income.

In light of this market, you might consider dollar cost averaging - buying a fixed dollar amount each month over a period of time. If the market continues to dip, you'll get more stock at a lower price.

tracy_tsc2000: Can our 23-year-old do this on his/her own or should he/she seek expert advice?

absenceofmalice asks: Any advice on how to find a good accountant to help with my taxes?

To answer both questions, there are many resources out there to learn about investing (the Ernst & Young Personal Financial Planning Guide for one). But you might want to speak with a full-service broker to help get your feet wet or a certified financial planner or CPA.

tracy_tsc2000: I get a lot of requests from readers for an accountant who is skilled in the rules surrounding traders? Any suggestions on how to find them?

martin_tsc: You can contact the AICPA or the local CPA society

tracy_tsc2000: B/C many accountants don't understand the rules! Ugh!

martin_tsc: Many accountants will be listed under a subspecialty including investment activities.

tracy_tsc2000: And not everyone has access to the big guns, like you, Martin.

martin_tsc: Make sure to ask your accountant these questions before you hire them.

tracy_tsc2000: Be sure to ask them if they have other clients who trade a lot.

maximus1033 asks: If I win 14,000 at gaming, yet lose 9,000 getting the win, how do I report to the IRS?

martin_tsc: The 14,000 is included in your income. The 9,000 is deductible as an itemized deduction. Although your deduction isn't just for the expenses on that win, all your gambling losses are deductible to the extent of that 14,000.

Save all receipts from gambling like losing tickets, race stubs, etc.; just make sure there are no footprints on them.

tracy_tsc2000: So that includes the lotto I lose every week?

martin_tsc: Yep, but only if you win and only to that extent.

tracy_tsc2000: So the moral is you have to win.

tinea1 asks: What is a good way for someone in their first year out of school to start saving money and invest?

tracy_tsc2000: Congrats for even thinking about this!

martin_tsc: The best investment vehicle out there is a Roth IRA

tracy_tsc2000: Go Roth! Especially for someone your age.

martin_tsc: Fund it now while you can because you may lose that ability once you start making more money. You can contribute up to $2000 every year up to the amount of your earned income.

tracy_tsc2000: Right -- once you start raking in the big bucks you won't be allowed to contribute to the Roth anymore.

martin_tsc: Then make sure you participate in your employer's 401k plan so that you get the maximum match.

tracy_tsc2000: Unless you're already making 6 figures ... don't tell me...

flyingpete_2 asks: Why do I pay taxes on a fund I haven't make any money on?

martin_tsc: Good point. Unfortunately the tax law is not always logical. You're paying tax on gains that the fund earned before you got in. But the gain you recognize gets added to your basis, so when you sell at some time in the future you recover that amount. Small consolation.

tracy_tsc2000: So it's all timing?

martin_tsc: Try to avoid year-end purchases before the fund has paid its distribution; that'll help you avoid the problem. But, as they say, timing is everything. Use software when possible to keep track of this stuff so you don't lose that basis increase and pay tax twice.

the8webbs asks: How can I avoid taxes on the profit from stock I inherited from my parents 10 years ago?

martin_tsc: Don't sell it.

tracy_tsc2000: That was my answer!

martin_tsc: Seriously though, your tax will only be based on the appreciation over the last 10 years. (Your basis is the value at the time you inherited.) If you sell in 2001 your gain would be taxable at only 8% if you're in the 15% bracket.

tracy_tsc2000: Again he took my answer.

martin_tsc: But you won't get the lower 18% rate since you got it before 2001.

tracy_tsc2000: He types fast for a two-finger typer!

brunoa99 asks: What are interest expense and expenses to be deducted?

martin_tsc: I assume you mean for a trader. Interest expense is interest on margin debt you incur to buy securities; other expenses might be professional periodicals, computer expense, etc.

brunoa99 asks: Wait, wait, wait -- he he he -- I am aspiring to be a daytrader not an investor, what can I do as far as the money I make from trades and the like? Can commission charges be considered expenses?

martin_tsc: Commission charges are capital expenditures that have to be added to the cost and deducted from the proceeds (although if your gains are short term that has the same effect as an expense). The money you make from trades will retain the regular character (interest, dividends, cap gain, etc).

riskarbitrageur asks: Hello and thank you in advance. I am a full-time trader. I trade from an S corp and all the income transfers to my schedule C. I have quite an elaborate home office and a lot of home office deduction to take. Can I take those deductions on schedule C or do I have to take it like an ordinary employee?

martin_tsc: If your trading activity is in your own name then your expenses are all deductible on your schedule C. Just make sure you note that you've treated yourself as a trader since your income will be someplace on your return and you'll look like all you have is a loss.

tracy_tsc2000: Is it a good idea to put your trading biz in a S-corp?

martin_tsc: No real reason to do it through an S since you could limit your liability in an LLC and a S corp could result in some unexpected local tax issues. In addition, your loss from an S corp may be limited because of basis issues; you don't get basis for debt incurred by the S.

tracy_tsc2000: How are your liability limited in an LLC?

Wait!

How is your liability limited in an LLC?

There.

Former English teacher here.

martin_tsc: An LLC is a limited liability company; if a liability arises (slip and fall, etc) you would not be personally liable.

tracy_tsc2000: So they can't come after the Mercedes then?

martin_tsc: Can't get out of margin debt though; the broker will require you to be on the hook.

brunoa99 asks: What are my odds as a Day Trader to receive an audit?

martin_tsc: The odds of being audited are lower than they've ever been, less than 2% for people making over 100k.

tracy_tsc2000: B/C the IRS is way way understaffed.

martin_tsc: But having a schedule C with losses is clearly not favorable in determining those odds.

tracy_tsc2000: Right -- it's a bit of a red flag.

martin_tsc: Let's say a pink flag.

tracy_tsc2000: Fair enough.

brownbagRipple asks: How and when do you arrange with the IRS to declare as a trader?

martin_tsc: You don't arrange with the IRS, this is your very own decision. (Let's hope you're right.) You may be thinking of the 475(f) election where a trader elects to be treated as a dealer that had to be done for 2000 by filing the election by 4/17/2000. Too late for this year.

brownbagRipple asks: Does the income limit of $100,000 to open a Roth apply to "unearned" income or only to "earned" income or both added together?

martin_tsc: The 100k limit is on a conversion and includes all income. For a new contribution to a Roth the limits are different.

tracy_tsc2000: That's converting a traditional IRA to a Roth. For married folks, your AGI is phased out from 150K to 160K on contributions.

martin_tsc: For singles the contribution limit is phased out between 95k and 110k.

tracy_tsc2000: And then if you file married filing separately, the phase out is from 0 to $10K.

Isn't that lame?!

martin_tsc: Sure is.

barky4 asks: If accrued but unpaid interest is included in the stepped up basis on an inherited account, when the account is liquidated is the interest taxed as interest or has it really become part of the basis?

tracy_tsc2000: Take it away, Martin. :)

martin_tsc: Accrued but unpaid interest is "income in respect of a decedent." That means it's not stepped up and the beneficiary is taxable on it when received. That's because it should have been taxed to the decedent, so it's taxed to someone eventually. The same applies to IRAs, pensions, unpaid salary, etc. But you do get an itemized deduction to the extent any federal estate tax was paid on that accrues interest.

pjacobson99 asks: Instead of selling stocks with large gains I've been shorting them "against the box" during market corrections to avoid paying lots of taxes; is that going to fly with the IRS?

martin_tsc: A short against the box still works as long as you close your short before January 31 of the following year and stay naked for 60 days.

tracy_tsc2000: Keep your pants on!

martin_tsc: Otherwise you'd have a constructive sale and would be taxed at the time you entered the short. Naked means that you don't hedge your position for 60 days after the close; i.e. you have market risk.

flyingpete_2 asks: Are dividends still better than a capital gain?

martin_tsc: Usually not since they're taxed as ordinary income.

tracy_tsc2000: Don't forget -- dividends are paid out in cash -- cap gain distributions are not.

So unless you reinvest your dividends, you can't add them back to your basis.

kittygirlsmom asks: Is it a good idea to purchase bonds?

martin_tsc: Again, you should look at your entire portfolio to determine an appropriate asset allocation: how much in equity, bonds, cash, etc. Once you've decided on an appropriate allocation buy those bonds!

Of course, some bonds have beneficial tax treatment like e-bonds. Where you don't pay tax on accrued interest until you cash them in and you may get an exclusion if you use them for college expenses.

riskarbitrageur asks: I am an S corp owner. I had the company buy my family a health insurance plan. Since I own the S corp I cannot write off the health insurance, but there is supposed to be a place on my 1040 where I can add back in 60% of the insurance expense. Where exactly is that place? Thanks.

martin_tsc: You would deduct 60% of your health insurance on Line 28 of your Form 1040. A way to deduct all of your health insurance (and maybe your medical expenses) is to hire your spouse as an employee and provide her with family coverage.

kvnmck11 asks: Regarding holding period if you get into a stock by exercising an option, does holding period begin at exercise or option purchase?

martin_tsc: Depends on whether it's a compensatory option or not. If it's compensatory your holding period starts at exercise. If it's not compensatory then the holding period depends on whom you bought the stock from. If you bought it from the company and did a cashless exercise, your holding period includes the time you held the option.

brunoa99 asks: Is there a book on taxes for traders or something to clarify all of this?

tracy_tsc2000: Aside from the truckloads of info you can get at TSC :) , check out www.tradertax.com/greenframes.html . They sell a great booklet that summarizes all these rules.

martin_tsc: There's also a good article in the AICPA tax adviser for October 2000, which came across my desk today.

tracy_tsc2000: Let me offer a huge amount of thanks to Martin for coming by and typing away for practically 60 min. straight to answer your questions!

Please come back again!

martin_tsc: My pleasure, always fun.

tracy_tsc2000: We covered loads of questions today -- and if any were answered -- be sure to send me an email at: tax [e-mail]

And I'll get Martin on the horn to help!

martin_tsc: Don't forget, only 185 days to April 15th!

tracy_tsc2000: Good luck filing your 1999 tax return! And join us in the weeks to come for our series on funding your child's college education.

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