Simply put, all else being equal, taxes due to the government are directly proportional to the money you’ve made. If you’ve never had to pay taxes on investments, forgiving significant write-offs elsewhere, you’ve never made money in stocks, unless of course we’re talking about qualified retirement accounts, and you will eventually have to pay taxes on those as well. Pay the taxes early and often, so that your desired moves are not hampered by large tax ramifications years down the road. If you hold profits long enough, you begin to think that’s your money. It’s not. Some of it belongs to the government. Would you rather square up with the government every year, or would you rather owe them 15% of a position that has grown 1000% over 20 years, a position that you’ve grown accustomed to thinking of as entirely yours over the years? Do you really want to be required to write a check to the IRS for $180,000 when you’re retired? Of course not. That money has become part of your retirement plan… you count it in your net worth, don’t you? C’mon… do yourself a favor and keep a current tax liability line-item handy to deduct against your net worth, because that money’s not yours.

Wash sale rule – is not so much a factor when dealing with IRAs, since taxable gains are not factored on annual basis, only upon distribution. In taxable accounts, the wash sale rule (simplified) disallows claiming a loss on a security if that security (or a similar one) is re-purchased within 30 days of the sell. This is important to take into account if you would like to use that loss to offset realized gains come tax time. However, while this should be kept in mind, most of the time it is not important since the losses realized under this methodology should be very, very small relative to gains, unless you have been able to hold a ton of winners past a year without getting taken out. And so if you see that you want to buy a stock back after taking a small loss because you were wrong at the onset, chances are, if you are right this time, there is more money to be made buying it back, building a position if it works, and realizing a profit; as opposed to how much would be saved by having that small amount to offset against gains or your taxable income at the end of the year.

Long-term vs. short-term gains. Long term gains are currently taxed at 15%. Short term gains are currently taxed at a level determined by your income tax bracket, and your income will be affected by those short-term gains, as well as any dividends collected. This is considered passive income (as opposed to earned), but you are still taxed on it. In general, when investing in an upward trending market, you want to hold onto your winners and sell your losers. So if a position is close to going long term (the 1 yr mark), you may want to make a judgment call and relax the stops on it, but I would recommend tax considerations on stock moves to be one of the last things you think about. Most of the money made in stocks when being active is made in time periods far less than one year. This outcome is dictated by the rules we have in place to protect profits and limit losses, encouraging continual compounding. So unless everything goes up with only minuscule pullbacks for more than a year, don’t get stuck trying to duck the difference in taxes. Longer term that will put you behind. But you can always use a handy tool called Gains keeper to easily assess your situation, and determine the best thing to do given extraordinary circumstances.

Once again, it’s very simple. If you made money, you’ll owe taxes. If you lost money, you won’t owe taxes, at least on that trade. If you are one of these people that does not want to make a decision because the IRS wants their cut, and this creates anxiety for you, have a nice day and good luck to you.

Gainskeeping software. A common concern for investors is dealing with tax-time worries. They figure that the more often they buy and sell, the more of a pain it will be when tax time comes around. And this is true if they attempt to keep records in a notebook (or Excel) and work solely off of those. Let’s face it; some people are never going to learn to use computers. But times have changed. All broker/dealer firms with any decent kind of technological platform have access to some form of gains keeping software. With my firm, there is a $25 annual charge for this service, and it takes literally no longer than ten minutes per account to run a report and send it out to the client, and this can be done on January 1st. That’s six weeks before most 1099s are sent out. This summarizes net short and long term gain/losses; giving you the number you’ll need to do your taxes. It has cost basis info on both a tax lot and a consolidated basis, and there are itemized trade runs (all buy/sell transactions for the full year.) All other sorts of wonderful stuff that can help you analyze last year’s performance can accompany this summary, complete with totals, so that you don’t even have to do simple addition. Any firm that tries to make you feel bad for needing cost basis info come tax time, or acts like it’s a service that justifies a higher level of compensation all else equal, is quite frankly, full of you-know-what. They’ve already chosen to forego giving you readily available tax analyses way before you receive the 1099, which usually comes in late-February. You could do an analysis of prior year account performance with the New Year only days old! Firms would much rather you have as little information as possible on your account though; this is why monthly or quarterly account statements for a lot of firms don’t have as much information as you would always like to see on there. Employing a long-term strategy in a world of unknowns is a crap shoot; so in the event the investor suffers losses that year, they don’t want the investor to see that, especially when fees and commissions charged can be a line-item for your consideration as well. Gainskeeper software. Use it. It’s a valuable tool.

So spending the first four months of the New Year with inactive capital, waiting for April 15th before making financial decisions, is no longer something you need to do. Keep records on all your other finances, call your accountant early in January and give him your best estimates. I have a great accountant. He spends ten minutes on the phone with me plugging in some numbers, and I know how my tax situation is going to play out weeks before the 1099s start to flow in. I pay him about $350 a year. I don’t know whether that’s high or low for the industry, but spending that $350 is worth it to me. Come April 15th, when everyone else is running around freaking out, my returns have been done for about 6 or 7 weeks, and new, clean dollars have been at work for almost two months. And, when I have something come across my desk in my business that I don’t know the answer to, he advises me at no cost. So get yourself a good accountant and get your taxes done before March hits. Then you have clarity to make decisions early in the year, avoiding yet another dead money trap. Why would you wait until right before May to put money back to work? I don’t “Sell in May and go away” but other investors do, and you might notice this effect if you watch the markets long enough. Not to mention that winter turns to spring right about this time of year, and there’s much more pleasurable things you could be doing in April than your taxes. Keep on top of your tax liability, set aside the government’s share, and keep your money working for you.

RM ~March 2011