Tracy Byrnes
My neighbor never filed on April 15 and never filed an extension request (federal or state). She is all upset that the IRS will penalize her. I have tried to reassure her that since she is entitled to a refund (I estimate about $550) she can take her time. They won't prosecute. Please render your judgment to relieve her anxiety.
-- Robert Krejcik Robert, Tell your neighbor to relax. Penalties for late filing are based on the amount due. So if you're confident your neighbor doesn't owe any taxes, she won't owe late filing penalties or interest, either. Still, while the Internal Revenue Service is not going to lock her up for not filing her Form 1040 - U.S. Individual Income Tax Return, that does not mean she should put it off. By not claiming her refund, your neighbor is giving Uncle Sam an interest-free loan. Uncle Sam is investing her refund money and making interest on it. Your neighbor should be making those profits instead. Let's assume she filed when she should have on April 17 (April 15 was a Saturday this year), received her refund on, say, May 1, and immediately invested that money in the market. Granted, the market's been pretty flat these last few months, but even the 2% increase in the S&P 500 index since then would've been better than nothing. If, instead, she put that refund into Intel (INTC Quote - Cramer on INTC - Stock Picks), she would've seen a 10% return on her investment. Not bad for a few months. She still won't fill her tax return? Tell your neighbor I'll prepare her tax return for her if she lets me hold on to her refund for at least four months.Covering Calls Again
Last week, I discussed the tax implications of writing covered calls, but I didn't address what happens, taxwise, when the underlying stock is called away and the seller doesn't want to give it up. So let's do that now. First, some review: Calls are a type of option that gives the purchaser the right to buy a security at a specified price at a certain time. It's a way of betting that a stock will rise. Investors who sell covered calls are taking the other side of that deal. When they sell (or in market parlance, "write") calls, they agree to deliver shares of a particular stock if the buyer of the call exercises his option. The seller, or writer, gets a fee called a premium for taking on this obligation. If all goes well for the writer, the option will expire -- in anywhere from a few days to a year or longer -- and the writer walks away with the premium. A call is "covered" when the seller owns the underlying stock. But what if those shares are called away -- that is, the buyer exercises the option -- and the seller doesn't want to deliver them? The seller has two choices, both of which bring up some hairy tax issues. He can buy the option back or go into the market and buy new shares of the stock to deliver to the buyer. Let's say you sold a $20 call for $3 in premium. That means the buyer has the right to buy the stock at $20 a share. But the stock now is trading at $30. Obviously, the buyer wants to exercise his call, pay you $20 for the stock and pocket $10 in profit. But let's say you originally bought the shares for $2, and you'd rather not generate huge capital gains taxes by selling them now. Or maybe you believe the stock is going to go even higher. Either way, you're holding on. You can buy the option back, no doubt at a higher price. Let's say you bought it back for $10 and wound up with a $7 loss on the deal. Can you take that loss on your tax return? No. You cannot declare that loss until you sell your original long position. But you can bank the loss until you do. Your other option is to go into the market and buy more stock at $30. Your buyer is only going to give you $20 for each of them, though. So you have a $7 loss -- the $10 price difference minus your $3 in premium -- on each share in this deal. Again, you can't take this loss until you sell your original long position. It's important to be aware of these implications because "many times investors write calls with no intention of selling the stock," says Rande Spiegelman, a senior manager in KPMG's investment advisory services group in San Francisco. "Most people write calls thinking the stock is going to go down. But they have to be prepared if stock goes up." There's one quirk in the tax laws that allows you to declare the loss on that trade if you wrote a "qualified" covered call. This type of call must have more than 30 days to expiration and have a strike price (the price at which the holder has the right to buy it) that is within $2.50 to $5 of the stock's price on the day it is sold. The tax rules surrounding options trades are precarious, so be sure to check out Publication 550 -- Investment Income and Expenses for more details.Send your questions and comments to taxforum@thestreet.com, and please include your full name. Tax Forum appears Tuesdays, Thursdays and Saturdays.
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