Welcome back to the Tax Forum. We've got margin interest, estimated taxes and life insurance to sift through today.
And stay tuned for a special Tax Forum for day traders next week. We'll answer many of the questions you sent in following our recent
Taxes for Traders series.
Let Tax Forum Do Your Taxes
Having a tough time with your tax return? We can help. The catch is, we'll do it in public.
We're looking for interesting tax returns to complete as part of a series of stories that will run in March. We'll get help from several top-notch experts in preparing the returns. There's no cost to you, but, like we said, everything will be done in public. We'll post some of the more complicated parts on the site -- that means all the numbers -- and explain everything to our readers so they can learn too.
We'll pick the returns we think are the most interesting and have instructional value for the widest range of readers. We're not looking for returns that include little beyond salary income, interest and dividends. But if you have capital gains or losses, self-employment income or if you sold or bought a house or a business, drop us a line.
One more thing: We're not your accountants, and we can't guarantee the results. In the end, you'll be completely responsible for the return you file.
If you're interested, send your full name and a brief description of the more difficult areas of your return to
firstname.lastname@example.org. If we choose your return, we'll contact you within a couple of weeks.
Super Bowl Tax Follow-up
Congrats to the
. Did you bet on the game? Don't tell me. I don't want to know. But if you did happen to place a winning bet in Las Vegas, we reported last week that you'd receive a
- Certain Gambling Winnings
from the casino documenting your winnings. Well, it turns out the casino is not required to send you one. The
Internal Revenue Service
is leaving it up to you to report your winnings on your tax return.
Do you have any other tax reporting questions? Send them to
email@example.com. Please remember to include your full name.
Now on to your questions.
Penalty for Late-Year Cap Gain?
I have a question concerning penalties and interest when taking capital gains. Suppose you are in a situation in which you've locked in a capital gain from the sale of stock in December. Obviously the tax needs to be paid in that year, but the gain was substantial enough to put you into a higher bracket. How does the IRS resolve how much penalty and interest needs to be paid on the unpaid taxes when April comes around? Since the gain was not recognized until December, I would think that it is unreasonable to expect to pay interest for the entire year or even a penalty since it is non-recurring income. -- Frank Lombardi
We have addressed this issue
before but this is a confusing area of the tax law. So it's worth reiterating the rules.
Capital gains have become so bittersweet. At first, you're elated because of the money you earned. But that euphoria is immediately overshadowed by the realization that you have to send a good portion of that money to Uncle Sam.
But on top of the capital gains tax you now owe, you may also need to make estimated tax payments. So let's run through a quick
estimated tax payments refresher.
First determine whether you owe more than $1,000 in 1998 tax after deducting your withholdings and credits. If you won't, then you're done. You don't have to make estimates.
Let's assume that you owe more than $1,000 in tax for 1998. Now you must figure out whether, through withholdings and credits, you will have paid either 100% of 1997's tax or 90% of 1998's. (Check out the great chart in
- Tax Withholding and Estimated Tax
Let's assume you come up short. You have a few options.
Make an estimated tax payment. Technically, a fourth-quarter payment was due on Jan. 15. So you will be charged interest from Jan. 15 until the day the IRS gets the payment, but it's pretty minimal. The rate is the Fed's short-term rate plus three points, compounded daily, says Rande Spiegelman, personal financial services manager at
. That's around 9% annually, which breaks down to around 0.02% a day.
But you can't just cut a check equal to the capital gains amount. Your estimated tax payments are supposed to be paid in equal amounts throughout the year. So if the IRS receives a big payment in the fourth quarter, it'll assume you've underpaid the first three-quarters and penalize you.
You must therefore annualize your income before you make a payment, says Spiegelman. Annualizing your income means that you take your year-to-date income and assume you earned that sum in equal amounts spread throughout the calendar year. (Check out this
previous story for the details on how to annualize your income.)
If you do annualize your income, you also must file
- Underpayment of Estimated Tax by Individuals, Estates and Trusts
. This form will alert the IRS that your income hasn't been a steady stream throughout the year because it will show the quarterly flow of your income.
This form will also walk you through the annualization process and help you figure out your fourth-quarter estimated tax payment, as well as any penalties and interest you might owe for underwithholding in previous quarters.
In any case, the sooner you file your 1998 tax return, the better, says Bill Fleming, director of personal financial services for
. You will owe interest from the day you should have paid until the day you actually do, says Fleming. So the sooner you pay
, the sooner you can stop the interest clock from ticking.
Where Do I Report My Roth Contributions?
Which IRS form do you use to file your 1998 Roth IRA contribution? It seems that Form 8606 Part I only applies to non-deductible contributions for Traditional IRAs and that Part II is only for Roth conversions. -- Jason York
Line 19a, Roth IRA contributions, of
- Nondeductible IRAs
does ask for your 1998 Roth IRA contribution, says Martin Nissenbaum, national director of personal income tax planning at
Ernst & Young
. Line 19a is in
Part III - Distributions for the Roth IRAs
But if you are not taking a distribution from the account, then you are not required to file Part III of the form at all.
So how do you keep track of your Roth IRA contributions? The
instructions to Form 8606 actually include a worksheet on page 6 that you should fill out and file away, even if you don't have to file Part III of the form. And hopefully, your IRA account's custodial agent is keeping track as well, says Fleming.
In addition, it would not hurt for you to start keeping a log of your contributions until the IRS gets its act together.
Hold Margin Interest Until Next Year?
I'm a bond trader who has rung up about $9,000 in margin interest this year. I am averaging about $1,000 a month in margin interest. Looking ahead to 1999, this trend will continue until about May when a maturing security will pay off the margin loan. Since margin loan interest can be carried over from year to year, could I bypass taking the margin loan deduction this year and wait till the next year and take the entire amount? -- Daryl Nichols
Margin interest is a form of investment interest. So assuming your margin interest pertains to your bonds, you
deduct it, along with any other investment interest, up to the amount of investment income. (See Section
163(d)(4)(b) for examples of investment income.)
As long as you have investment income, you cannot opt to save all the interest for next year. You will lose the interest deduction if you do.
Note that if you're dealing with tax exempt bonds, any related margin interest is not deductible, says Fleming.
Only if you don't have enough (or any) investment income to cover your interest, can you carry the interest forward and try again next year. (See
- Investment Income and Expenses
for more details.)
Your only other option is to capitalize the interest, says Nissenbaum.
Section 266 of the tax code will allow you to add the corresponding interest to the basis of the bonds. Note that this will decrease your gains and increase your losses, but for tax planning that may suit your needs.
Need Life Insurance at 29?
I'm 29 and thinking about an insurance policy. I guess I'm figuring it should be pretty cheap at my age and friends in the business tell me that whole life is very similar to a Roth IRA (the tax-free cash value). However, I am aware how lucrative life insurance is to its peddlers. I'm wondering if it's a better strategy to buy term insurance and then invest the difference in, say, the (VFINX) - Get Report Vanguard Index 500 -- assuming a 30-year-plus time horizon. Let's assume I'm willing to shell out $200 a month. That should buy me a $250,000 whole life policy. -- Mark C. Militell
It sounds like your friends are trying to pitch life insurance to you as an investment possibility. But there are so many less expensive investment options out there.
Are you married? Do you have kids or other dependents? Do you own your own business? If you answered "No" to all of these questions then most financial planners would not recommend that you buy life insurance at this stage of your life. (Check this
column out for more tax tips for singles.) It's just a wasted cost for you.
Granted, there are attractive tax features to life insurance policies -- like tax deferral on the account's earnings -- if you are in the higher tax brackets. And if you have a family to care for eventually, then it may be cheaper to get your policy now, notes Nissenbaum.
But there are drawbacks to these plans. If you do not have beneficiaries right now, you'll be paying for a death benefit you just don't need. That's throwing money away. Generally, large amounts of money are required up front and you won't have access to any of it in the beginning.
Fleming estimates you're looking at 15 to 20 years just to break even with a life insurance policy. You need to weigh the after-tax rate of return of the policy against that of another investment vehicle to determine if this is the right way for you to go. The Vanguard Index 500 -- or any other mutual fund -- might be a better, cheaper option for you.
TSC Tax Forum aims to provide general tax information. It cannot and does not attempt to provide individual tax advice. All readers are urged to consult with an accountant as needed about their individual circumstances.