This week a reader promises to sign up for a lifetime subscription if
can answer a question about his limited-liability company. We're going to work real hard on that one.
We'll also discuss mandatory withholdings on the sale of stock and what to do if your shares were sold in two lots.
There's also a follow-up for those of you who were at the Money Show in Las Vegas a few weeks ago.
Keep sending your questions, along with your full name, to
Reader's LLC Challenge
I know I will have short-term capital gains in 1999 and probably 2000. I will be investing in a startup limited-liability company in which I will own 51% of the equity. The LLC will be borrowing money to buy an asset that will eventually be sold for a capital gain (I hope). Can I deduct 51% of the interest expense from the LLC to offset short-term capital gains this year? If you can answer this, I will renew my subscription to
forever. -- John S. Boyd
I'm up for the challenge. Here goes:
The interest expense from the LLC will flow to you and should be reported on your tax return.
Investment income normally consists only of interest and dividends -- capital gains are excluded, says Ted Tesser, author of
The Trader's Tax Survival Guide
But -- there's always a but -- you can make a one-time election "to include all or part of your net capital gain from the sale in investment income," according to the
Internal Revenue Service's
- Investment Income and Expenses
You would report that amount of capital gains to be treated as investment income on Line 4e of
- Investment Interest Expense Deduction
So let's say your net capital gain was $10,000, but you want to claim $5,000 as investment income to be used against your investment interest. You'd report $10,000 on line 4c and $5,000 on 4e. That amount could now be considered investment income and could be offset against your interest expense, says Tesser.
"But now you can't get the beneficial 20% rate on that amount," notes Richard Shapiro, an
Ernst & Young
securities tax partner in New York. That's because your final step is to include the amount you reported on line 4e of Form 4952 on your
- Capital Gains and Losses
. That amount now would be subject to your regular tax rate. So if the amount qualified for the long-term capital gains rate, you just lost it.
I'll forward your name on to the membership services people so you can sign up for your lifetime subscription.
Withholding on a Stock Sell?
A friend of mine wants to sell some stock but there is a mandatory backup 31% withholding, which may be too little for this person's bracket. Does my friend owe the excess tax immediately or next year if he sells now? Also, there is a 10-cent-per-share fee for the sale -- is this a deductible expense? How would that get reported? -- Bryan McCormick
When a brokerage account is set up without a Social Security number, a 31% mandatory withholding is taken out of all sales proceeds, notes Jim Calvin, an investment management tax partner at
Deloitte & Touche
in Boston and editor-in-chief of the
Journal of Taxation of Investments
. In addition, if you -- or your "friend's" -- Social Security number was included but incorrectly recorded, Social Security won't recognize it.
The 31% is withheld on your sales price, regardless of whether you generated a gain or a loss. So if you bought the stock at $200 and sold it at $100, 31% still would be withheld on that $100.
The withholding most likely will be taken after each transaction. At year-end you'll get a Form 1099 that will include the amount withheld on your gross proceeds.
The excess tax does not have to be paid at the time of the sale, says Tesser. So it will be added to your tax bill at year-end. But if it's a large amount, you may need to make an estimated tax payment before that. See a previous
Tax Forum for more on estimated payments.
And that 10-cent-per-share cost will reduce the proceeds of the sale. "By the way, who pays 10 cents a share anymore?" asks Tesser. Try a discount online broker in the future.
Shares Sold In Two Lots
I recently sold 1,600 shares of Dell (DELL) - Get Dell Technologies Inc Class C Report. When I checked my confirmation, I discovered that the shares were sold in two lots. One lot comprising 1,403 shares was sold at 33 7/8, the other lot for 197 shares was sold for 33 3/4. How do I report this on my income tax return? As two separate sales or as one sale with the prices averaged out (weighted of course)? -- Marty Mesher
First, there are legitimate reasons why your lot was split. Sometimes the broker can process the whole trade at the same time; sometimes it can't, notes Shapiro. If you're concerned, just call your broker.
Since your sale was split, it's technically two trades. You therefore should report it as two trades, especially if your broker does. If at year-end, your broker records two transactions, the IRS' computer system will be looking for two trades when it attempts to match your return to the broker statements. A mismatch will generate correspondence between you and the service, and I know you don't want that.
Certified Receipt Certifies Nothing
wrote in to tell us that her tax return got lost in the mail. We suggested that she send her tax return certified mail next time.
But sending your return certified mail with a return request is "for the birds," says reader
. He did it and the IRS claimed it never received his tax return or the receipt.
Even worse, it took the post office four to six weeks to confirm that his "certified" return had been delivered to the IRS. He ended up resending his tax return.
So next year, everyone should try to
file electronically. Then you can avoid postal problems entirely.
Note to Money Show Attendees
On June 7 at the Money Show in Las Vegas, I gave a presentation on how to research, prepare and file your tax return online. A question came up about whether a trader could have an IRA or a Keogh, and I did not have time to address it. So here's the answer.
If you file your tax return as a trader and elect to report all your income and expenses on
- Profit or Loss from Business
, you do not pay self-employment tax. (See our
Taxes for Traders series for the details on that.) That means you're not paying into the Social Security system and you don't qualify for a Keogh, a self-employed person's retirement plan.
To contribute to an IRA, you need earned income, i.e. wages, salaries, tips, other employee compensation and net earnings from self-employment. But since you don't pay self-employment tax, you don't have self-employment income. As a trader, you most likely don't have any earned income so you're precluded from contributing to an IRA as well.
But check out this previous
Tax Forum for other options on retirement savings for traders.
Viva Las Vegas!