Capital Gains, Dividends, and Taxes

I've come across these questions several times in the last few days, so I thought I'd answer them to dispel some intuitions novice investors have.

1. If I reinvest my dividends, do I have to pay taxes on them?

Whether you reinvest your dividends or not, this decision will never (unless tax laws are changed) affect your taxes. Whether your dividends are taxed depends on what dividends you're talking about and in what kind of account you're receiving them.

Let's start with regular stocks--like the ones traded on NYSE, NASDAQ, and Pink Sheets. In a regular, taxable brokerage account, or if you buy directly from the company in a taxable account (e.g., not as part of a 401(k), etc) you have to pay taxes on all your dividends. It does not matter if you reinvest your dividends or not. There are two ways in which regular stock dividends are taxed: ordinary income and qualified dividends.

The ordinary income tax rate on dividends, or the ordinary dividend tax rate, is based on whatever tax bracket you're in. Let's say you're in the 25% tax bracket. That is how much tax you'd pay on your dividends if they're taxed as ordinary income.

The qualified dividend rate, at least for now, is much lower. It also depends on your tax bracket, but the maximum rate is 15%. For people in the lowest tax bracket, the rate on qualified dividends is 0%. This will probably change in the future, especially if the Democrats control all the branches of the government.

The way your regular stock dividends in a taxable account are taxed depends on how long you hold the dividend paying stock. If you hold the stock for more than 60 days during the 121-day period that begins 60 days before the ex-dividend date (the ex date, etc is explained here), your dividends are taxed at the qualified dividend rate.

Many companies also have preferred stocks, which trade on the exchanges like regular stocks. These usually pay out a big dividend, have a narrow trading range, and the company reserves the right to buy the stock back for a certain price. If the company goes out of business, holders of the preferred stock have priority over holders of the regular stock in terms of who gets what of the company's remaining assets (the order of priority is bondholders, preferred stockholders, and regular stockholders).

There are two types of preferred stocks. The most common is a hybrid between a bond and a stock. The "dividends" the company pays out on these preferred shares are treated as debt. The company gets a tax break. As an investor, however, you incur the ordinary dividend rate, no matter how long you hold the stock. Only around 100 companies (mostly utilities) have preferred shares that pay out dividends that can, if you hold them for the requisite period, be qualified dividends. They typically have lower yields.

There are also tax exempt "dividends." These come from municipal bond mutual funds and closed end funds that invest in municipal bonds. Here is a great article on such closed end funds. I put dividends in scare quotes because they're not really dividends. The payments you receive from municipal bond funds are actually tax free interest payments. Depending on the fund, some, usually a very tiny percentage, of the payments you receive may count as something called "private activity bond interest." This "is interest paid by private activity bonds, issued to encourage private-sector investment in the development of certain facilities which serve various specified public purposes, and exempt interest dividends paid by mutual funds that are attributable to such interest." Private activity bond interest has tax implications. While municipal bond interest is exempt from federal taxes, you may still have to pay state taxes on your "dividends."

2. If I reinvest my profits or capital gains, can my taxes be deferred or exempt?

No. Every time you sell an asset for a profit in a taxable account, you incur tax liability. It does not matter if you use your profits to invest in something else.

There are two types of capital gains: short term and long term. Short term capital gains are taxed as ordinary income. Whatever tax bracket you're in is the rate at which your profit is taxed. For simplicity's sake, let's take a regular stock as an example. Suppose you buy GE in a taxable account, hold it for less than a year, and then sell it for a gain of $200. Let's say you're in the 25% tax bracket. You'll have to pay $50 in taxes (25% of 200).

Long term capital gains rates also depend on your tax bracket, but they are lower than the ordinary income rate. The maximum tax rate on long term gains is 15%. Taking the same example, suppose you buy GE in a taxable account, hold it for over a year, and then sell it for a $200 gain. Suppose again that you're in the 25% tax bracket. You'd have to pay $30 in taxes.

Here is a great little calculator for short term and long term capital gains taxes. The thing to remember is that to qualify for long term capital gains rates you have to hold your stock for at least a year and a day.

Mutual funds and ETFs (some, not all) pay out dividends, some of which can be counted as ordinary dividends, qualified dividends, short term capital gains, and long term capital gains. It depends on what the fund invests in and what the fund manager does. The more active the manager is in trading stocks, the more likely you are to receive ordinary dividends and short term capital gains. Once again, it does not matter whether you reinvest your mutual fund and ETF dividends. As long as you hold them in a taxable account you're going to pay taxes on them.

The way to avoid taxes on your capital gains and dividends is to receive them in a tax deferred (such as an IRA or 401(k)) or tax exempt account (such as a Roth IRA). With an IRA, you only pay taxes when you start taking money out after retirement. With a Roth, you pay no taxes, since you're investing with after tax money. For more on this, click here or here.

The bottom line is that reinvestment has nothing at all to do with taxes. Whether you pay taxes (and what rates) depends on what kind of account you're holding your assets in, how long you hold them, and what kinds of assets they are.

Source: Slacker Wealth

What Happens if I Don't Pay the IRS?

Depending on how much time has past, an individual will see hundreds; even of thousands of dollars owed in back taxes that were not originally assessed when first receiving a letter from IRS. Similar to a credit card company, penalties and interest can and will be applied.

Delinquent Income Tax Return Defined -
A delinquent income tax return is defined, in the eyes of the IRS and federal government as:

Income tax return having a US mail postmark after April 15th, if an extension was not granted. If an extension was applied for and granted, a delinquent income tax return is defined as an income tax return with a US mail postmark after the due date of that extension.

Does the IRS Keep my Return Money if I am Late? -
After three years, yes. There is a statute of limitations, or certain period of time allowed, by the federal government applied to receiving income tax refund money for a given year. That is three years from the due date of the tax return, not January 1st.

Just think, you could have money owed to you that you could apply toward your IRS tax debt if you have not filed.

Tax Return Stature of Limitations Example -
For example this is 2007, if your unextended delinquent income tax return for 2003 is fixed this year, you must do so before April 15th, 2007 to receive any refund from the IRS.

After that date, the government legally does not have to pay any refund owed even if it is thousands of dollars. If you mail or the return after the third anniversary date, the IRS will keep your refund check.

Delinquent Tax Penalties & Interest -
If you owe tax from the year's income, you could possibly be subjected to several penalties on the amount due. The failure to file penalty assesses a 5% charge on the amount due each, up to a maximum amount of 25%.

The failure-to-pay penalty equals one-half of 1% of the amount owed per month, maxing out at 25% as well. You will be charged interest on an unpaid balance at the prevailing rate (varies month-to-month).

You may be subjected to a penalty for not paying sufficient estimated taxes. There are several other penalties that may also apply.

If you have not filed and have not heard from the IRS, it is only a matter of time, even if you have not heard from them in years. They will contact you and find a way to collect.

How the IRS will Settle Delinquent Taxes by Force -
If none of these previously mentioned options above are arranged, some of the enforced collections measures the IRS can use, but are not limited to:

- Wage attachments
- Bank Account Levies
- Seizures of property
- Referrals to a private collection agency
- License or permit revocations
- Corporate responsible person assessments

Do not let the IRS scare you into signing an agreement that demands high dollar tax payments that you can not afford. Let a tax professional with years experience working with the IRS help you.

Author: Neil from Articles Alley

Are You Required to Report Your eBay Earnings?

Many people ask me if they are required to report the profits they earn on items they sell on eBay on their income tax return. In short, yes.

If you sell items on eBay for a profit, then you should report your eBay sales on your income tax return, and you may owe income taxes on any profits. It doesn't matter if its just a hobby or if you are trying to build a business - if you earned a profit, its taxable income.

Generally, any income you receive from all sources is subject to income tax unless it is specifically exempt by law (hint: eBay profits are not exempt).

You must file a tax return if your net earnings from self employment are $400 or more. You are self employed if you carry on a trade or business for profit. If you are selling on eBay with the intent of making a profit, then you are self employed.

To report your eBay earnings, you should file Form 1040, and attach Schedule C or C-EZ. Schedule C is used to calculate your net profit or loss from your business, which is then reported on your Form 1040. This is assuming you are a sole proprietor. If you are incorporated, you have to file a separate business return. You will file Form 1120 or Form 1120s (for S Corporations). If you are a partnership, you will file Form 1065.

At this point, you may be thinking 'I don't run a business; I just sell on eBay as a hobby'. Unfortunately, income from hobbies is taxable as well.

You should decide before you even start selling on eBay if you will be running a business, or if this will just be a hobby, or if you are just selling off collectibles. Each choice has its own tax consequences and its own reporting requirements.

If your eBay income is a hobby, you still report your income and expenses, but you are not allowed to deduct expenses in excess of your income. Your hobby income is reported on line 21 of Form 1040; expenses are reported on Schedule A as a miscellaneous deduction, subject to the 2 percent Adjusted Gross Income (AGI) floor. This means if you do not itemize you could lose the ability to deduct any expenses against your hobby income, and even if you do itemize, you can only deduct the amount of expenses that exceed 2 percent of your AGI.

If your eBay income is from the sale of collectibles (artwork, antiques, stamps, coins) then you will report the gain from your sales on Schedule D. The capital gain tax rate for collectibles is 28 percent. Losses on the sale of collectibles are not deductible.

As you can see, it is very important to decide how you will be treating your eBay activity so you'll know your tax responsibilities from your activity from day one.

Author: Kristine from Articles Alley.

Rebares: What you need to know

Lawmakers have given their final seal of approval to a $170 billion plan intended to spark the slowing economy.
The plan's centerpiece: tax rebates.

But questions remain about how the program will work, and officials at the Treasury Department and IRS are scurrying to work out the details.

In the meantime, here are some answers based on currently available government information and experts' analysis.

Do I qualify for a rebate and how much can I expect?

One-time rebates will be sent to at least 117 million low- and middle-income households, 20 million senior citizens living off of Social Security, and 250,000 disabled veterans.

To be eligible for a full rebate, single tax filers must have 2007 adjusted gross income (AGI) below $75,000 and joint filers must have AGI below $150,000.

Adjusted gross income is not your annual salary. It's equal to gross income minus "above the line deductions," which are reported on page 1 of the 1040 tax form. Above-the-line deductions include deductible IRA contributions, alimony paid and, for the self-employed, some portion of money spent on health insurance or Social Security.

Single filers with AGI below $75,000 will get rebates of as much as $600. Couples with AGI below $150,000 will receive rebates of up to $1,200.

In addition, parents will also receive $300 rebates per dependent child; there is no cap on the number of children eligible.

An example: A couple with one child and $100,000 in AGI will get a rebate of $1,500 ($1,200 + $300). If they have two children, they will get $1,800 ($1,200 + $600).

Tax filers who do not owe income taxes because of various credits and deductions but have at least $3,000 in income - which can include Social Security and disability payments - will get $300 rebates per person or $600 per couple.

I make more than the income caps. What about me?

You might get a partial rebate. It depends on how much your income exceeds the caps.

The stimulus legislation allows for a 5% phaseout rate for households above the income caps of $75,000 for single filers and $150,000 for joint filers.

That means that for every dollar a tax filer earns above those caps, he or she will lose 5 cents of the rebate, said Jason Furman, senior fellow at the Brookings Institution.

Put another way, the rebates of those taxpayers will be reduced by the amount of income above the cap multiplied by 5%, said Mark Luscombe, principal analyst at tax information publisher CCH.

Take a couple with two children. If they make less than the income cap, they will likely get an $1,800 rebate. If they make $15,000 more than the cap, they will see their $1,800 rebate reduced by $750 ($15,000 x 0.05). So instead they will receive a check for $1,050 ($1,800-$750).

A childless couple whose AGI falls below the cap will likely get a $1,200 rebate. But if their AGI exceeds the cap by $15,000, their rebate will be reduced by $750. So they'd get a check for $450.

Single filers with no kids and an income below $75,000 will likely get a $600 rebate. But if they made $80,000, their rebate will be reduced by $250 ($5,000 x 0.05). So they will get a check for $350 ($600-$250).

The point at which the rebate gets phased out entirely will vary. For example, a single filer with no kids whose income exceeds the cap by $12,000 or more will get no rebate, because it will be reduced by an amount equal to or greater than the $600 ($12,000 x 0.05 = $600).

Do I have to pay the rebate back?

No. And here's why.

Your rebate is a one-time tax cut - an advance on a credit you'll receive on your 2008 return.

It's based on your 2007 income initially. If it turns out that your 2008 income and number of children would have qualified you for a larger rebate than the one you received, you'll be sent the difference. If it turns out your 2008 income was lower than in 2007 and you should have gotten a lower rebate, you get to keep the difference.

"If you were supposed to receive a larger payment than you did, you will get the extra money," said Treasury spokesman Andrew DeSouza. "If you received more than what you should have gotten, you will not be penalized."

What do I have to do to get one?

You must file a 1040 or 1040-EZ federal tax return for 2007.

Some people are normally not required to file a return. To get the rebate, however, they have to file a federal tax return.

So when will I get a check?

Treasury Secretary Henry Paulson said Thursday night that the IRS will start sending out checks in early May. Last month, he said it should take about 10 weeks to crank out all the checks. In all likelihood then, you'll see the money sometime between May and early July.

That assumes, of course, that you hit the IRS deadline and file by April 15.

If you're a laggard and have to file for an extension, you'll still get a check but it may not come until the end of the year - probably in time for Christmas shopping.

By Jeanne Sahadi @ CNNMoney.com

Save First, Pay Taxes Later

Most people pay everyone else first -- taxman, landlord, credit-card company, and so on. They try and budget every week, month, and year hoping that if they're careful they'll have some money left over.

This is absolutely, positively backwards. And because of it over 70 percent of Americans continue to live paycheck to paycheck regardless of increasing incomes. We make more. We spend more. And at the end of the day we're still broke. Are you tired of this game?

"Pay yourself first" means just what it says: When you earn a dollar, the first person you pay is you. Sounds simple, but most people don't do it.

Instead, the first person they pay is Uncle Sam. They earn a dollar and before they even see it, they pay around 20 to 30 cents in federal income tax. Depending on the state they live in, they may pay another 5 cents in state income tax. On top of that, there's Social Security, Medicaid, and unemployment. In the end, the government gets as much as 35 to 40 cents of their hard-earned dollars.

The Taxman Gets Smart

The government didn't always get first dibs on our paychecks. Before 1943, folks got their hard-earned paychecks first and paid taxes later. There was a problem with this system, however: People weren't saving enough money to pay their taxes. They spent what they earned and when it came time to pay taxes they didn't have the money.

So the government created a system under which it got paid automatically every time we got paid. And that system has worked for the government for over 60 years. But how is it working for you?

My point here is not to have you break the law, but rather learn from the government.

You have a right to legally avoid federal and state taxes on the money you earn. You can legally pay yourself first by simply using a retirement account. There are many different types, including 401(k) and 403(b) plans, IRAs and SEP IRAs. The one thing that makes all of these "pay yourself first" accounts is that the money you put in them is either pre-tax or tax deductible.

$14 a Day Could Grow Into a Cool Million

The most common question I get asked is, "How much should I save?" Your goal should be to save one hour a day of your income.

If you start this week by having one hour a day of your income deposited into a 401(k) plan at work, you will be in fantastic shape. If your employer doesn't offer a retirement account, go to a bank or brokerage firm (on- or offline) and set one up.

Let's assume you make $50,000 a year. That's about $2,000 every two weeks, which is how most people are paid. So to save 10 percent of your income, which is less than an hour a day of savings, you'd have to save $200 every two weeks -- or $14 a day.

If you invested $200 every two weeks for 35 years in a retirement account that earned an annual return of 10 percent what would you have? Quite a pot of gold: $1,678,293.78.

Depending on how you calculate this and compound the interest it could be higher or lower, so don't waste time debating the calculation. The point is you can make a lot by setting up a retirement account that pays you before Uncle Sam takes his cut.

By David Bach @ Yahoo Finance