We've got two options questions this week, involving LEAPS and the wash-sale rule. Then we'll determine whether you can make catch-up contributions to an IRA, and we'll define earned income.
We'll also follow up on college savings plans and the
independence policy crackdown.
Any other tax issues driving you crazy? Send your questions to
email@example.com. Please remember to include your full name.
Looking to LEAP
I own Boeing (BA) - Get Report in both a taxable and tax-deferred account, at a very low-cost basis. In the taxable account, I may never sell it. Would it be wise to write LEAP call options? I guess the same question applies to the tax-deferred account. Would shorter options be a better strategy? What is the thinking in these situations? -- Ron Dunn
First, a reminder: LEAPS -- or Long-term Equity Anticipation Securities -- are options with expiration cycles as long as two years. Unlike traditional options that expire within months, LEAPS are set to expire in January of each of the next two calendar years. They are exchange traded and are most often used as a proxy for buying a company's stock.
Since you already hold the stock, you would be writing covered LEAPS. An option is considered covered when it is written against a stock that is owned by the writer.
This is a great strategy to increase your rate of return, says Ted Tesser, CPA and author of
The Trader's Tax Survival Guide
. But you may be hit with a large capital gain if the stock is called away. (That is, someone exercises the option and you need to deliver your long-held stock.)
Your decision to write short-term or long-term options really depends on your risk tolerance. By writing LEAPS, you are taking a bigger risk because there is less certainty about where the price will be when the LEAPS come due.
On the flip side, if you wrote, say, August calls, it might be easier for you to estimate your expected return.
Depending on your broker, you may not even be allowed to trade options in your tax-deferred account. If you are, you don't have to worry about incurring capital gains.
Options and the Wash-Sale Rule
Can I sell to take a tax loss on an option, then make an investment in a similar option within 30 days and still record the loss? For example, what happens if I sell 10 Chase Manhattan (CMB) Jan 75s at a loss, then immediately buy 10 CMB Jan 70s? -- E.C. Neu
You're talking about the wash-sale rule here, and this is a really gray area in the options world. The
Internal Revenue Service
has given us no real guidance on when the wash-sale rule interferes with an options trade.
The wash-sale rule says that if you buy a security, sell it at a loss and then buy back a "substantially identical" security 30 days
before or after the sale, you are not allowed to claim that loss on your tax return.
In the options world, the conventional wisdom is that as long as the expiration dates are varied, the options are not substantially identical. That means no wash sale. Options with different strike prices and expiration dates are even more in the clear.
But in your case, you are trading options with the same expiration date, assuming that the options expire in January 2000, not 2001.
So we have to do more speculating.
"One can argue that since every CUSIP number
a security's identifying number is different, the option is different," says Richard Shapiro, an
Ernst & Young
securities tax partner in New York. "But a lot depends on whether the strike is above or below the market price."
In your case, Chase Manhattan has been trading at 82. So the options probably are not substantially identical because of the large difference between the strike price and the current stock price.
"But this is very mushy, so speak to your tax adviser," urges Shapiro.
Check out the
mega-piece we did on the wash-sale rule for more details. And be sure to
Publication 550: Investment Income and Expense
for more of the tax details surrounding option trading.
Is there any way to catch up on missed nondeductible IRA contributions? For 10 years I was too stupid to make annual contributions. -- Charles Huffman
I'm sorry to say that you can't make catch-up contributions. The IRS doesn't care that you had a 10-year momentary lapse of reasoning.
Your annual contributions are limited to $2,000 -- regardless of what you contributed the year before.
And that $2,000 includes your deductible and nondeductible contributions, says Clarence Kehoe, partner and director of employee benefits at
Anchin Block & Anchin
in New York. So if you have a traditional IRA and a Roth IRA, your total contributions to both must not exceed $2,000.
Shake off those lapsed 10 years and get back on the contribution train now.
Is Rental Income Earned?
I understand that I must have earned income to contribute to an IRA if I am a daytrader. Does interest earned from a trust fund that I am the beneficiary of count? I also collect rent on a piece of rental property. Is that considered earned income? -- Louis Lobel
Sorry. Neither the interest from the trust nor the rental income counts as earned income, according to Kehoe.
As a reminder, earned income only includes wages, salaries, tips, other employee compensation and net earnings from self-employment. (Remember, as a trader, you don't pay self-employment tax so you don't have earnings from self-employed activities.)
More College Savings Info, Please
I enjoyed your article on college savings plans and am eager to do more education expense planning for my two little kids. However, you did not provide any useful links on this subject. Could you point out a few Web sites that offer further information on this area? -- Jerry Dong
I did include the
College Savings Plans Network's
Web site. The CSPN was created to help make higher education more attainable, so the site is the end-all, be-all for college savings plans. It is unbiased and gives you information on all the available state plans, including their respective Web sites and phone numbers.
William F. Tell
www.savingforcollege.com. This site is run by Joe Hurley, author of
The Best Way To Save for College
. In addition to the good plan explanations, also included are excerpts from his book and his personal review of each plans.
What is PricewaterhouseCoopers doing about spouses of managers that are daytraders? With today's proclivity for stay-at-homes to try to make money trading, this could be a hardship to some families. -- Bernie Nunez
recently announced that employees at the manager level would now have to follow the partners' independence policy, which disallows ownership of stocks, bonds, mutual funds or any other investments tied to companies the firm audits. Managers' spouses, cohabitants and kids must follow these rules as well.
The managers raised hell about the change.
So to quiet the riled crowd, PricewaterhouseCoopers loosened the policy. The firm decided to grandfather any stock holdings that managers, their spouses, cohabitants or kids were holding before June 17, 1998, assuming those holdings met the firm's longstanding independence requirements.
Although managers now don't have to sell their holdings, they can't add to them either. But they can continue any dividend reinvestment programs.
Going forward, though, the new policy still holds, says PricewaterhouseCoopers spokesman Dave Nestor.
So that means if you're the spouse of a manager or partner, you are covered by the policy. "So daytrading in audit clients is not permitted," says Nestor. The firm will provide you with a complete list of the clients you can't trade.
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.
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