Investment and Retirement Savings

The tax tail should never wag the investing dog, but failing to consider the tax consequences of your investing activities could knock some of the shine off your glowing returns. Here are some tax issues that affect every investor, and tips to help you keep more of your money.

And be sure to check out our other taxopedias.

What's Deductible? -- A to Z

A B C D E F G I K L M N P R S T W

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Accrued interest on bond purchases. If you buy a taxable bond at a market premium, you can elect to amortize the premium over the remaining term of the bond. The premium is deducted as an offset to interest income you report. This treatment does not apply to tax-exempt bonds.

Amortized bond premium. If you buy a taxable bond at a market premium, you can elect to amortize the premium over the remaining term of the bond. The premium is deducted as an offset to interest income you report. This treatment does not apply to tax-exempt bonds.

Bad debts. If you loaned money to someone and have determined that you will not be repaid, you can deduct the loss as a non-business bad debt, which is treated as a short-term capital loss for tax purposes. If your business made the loan as part of its regular operations, the loss is deductible against business income.

Capital losses. Losses on sales of securities and other investments are deductible within certain limits. First, long-term losses (from the sale of assets owned more than one year) are deducted from long-term gains and short-term losses (from the sale of assets owned one year or less) are deducted from short-term gains. Net long-term losses are then deducted against net short-term gains and vice versa. If transactions result in a net loss, up to $3,000 can be deducted against other kinds of income, such as your salary or taxable payout from a retirement plan. Any excess loss is carried over and used on your next year's return.

Depreciation of equipment to manage securities. If you use a home computer to track your investments, you can may be able to write off at least part of the cost.depreciate the cost over a six-year period. If you use the computer more than 50% of the time to track your investments, you can “expense” the cost. If you use the machine 60% for tracking your investments, for example, 60% of the cost could be deducted in the year of the purchase. If you don’t meet the 50% of use test, then the cost is depreciated, generally over six years. If you bought the computer before September 9, 2010, you can claim 50% bonus depreciation for the business portion of the cost, then depreciate the rest over six years. If you put the machine in use after September 8, then you can write off the full business cost under the 100% bonus depreciation rule. This In any case, this is a miscellaneous itemized expense deductible to the extent that it and your other miscellaneous expenses exceed 2% of your adjusted gross income.

Employer-paid retirement advice. The value of such advice is a tax-free fringe benefit.

Foreign tax credit on dividends. If you paid foreign taxes on dividends you received, claim an income tax credit to recover the cost via lower federal taxes.

Gains on empowerment zone assets. Gains on the sale of business assets located in areas designated by the government as empowerment zones are tax free if you have owned the assets more than five years. The required holding period drops to one year for sales of business assets in designated renewal communities and enterprise communities.

Gains on small business stock. Special rules apply to profit on You can treat as tax-free half of your gain on the sale of qualifying small-business company stock that you have owned for more than five years. The corporation issuing the stock cannot be an S corporation, and the stock must have been originally issued after August 10, 1993, by a corporation that had less than $50 million in assets. There's a long list of ineligible business, including those in the fields of health, engineering, arts, athletics, law, financial services, insurance, leasing and similar service businesses that depend on skills of a few employees. Also, corporations involved in farming, hotels and restaurants are not eligible. Depending on when the stock was issued, a portion of the profit(at least 50%) is tax free and the rate on the rest is 28%. For qualifying stock purchased after September 27, 2010 and before January 1, 2011, for example, 100% of the profit is tax free, if the qualifying stock is held for at least five years.

Investment advice. Amounts paid for financial planning, tax or investment advice, including periodicals, investment newsletters, tax-preparation software and online services qualify as a miscellaneous itemized deduction deductible to the extent that it and your other miscellaneous deductions exceed 2% of your adjusted gross income.

Individual 401(k). This relatively new retirement plan for self-employed taxpayers often allows the highest percentage of self-employment income to be stashed in a tax-sheltered account – for 2010 up to $16,500 ($22,000 for those at least 50 years old at the end of 2010) plus 20% of income up to a maximum contribution of $49,000 ($54,500 for those at least age 50) -- and deducted from income. The plan must be opened by December 31, 2010, but contributions can be made until the due date of your return.

IRAs. For 2010, you can contribute up to $5,000 to a traditional individual retirement account if you have that much earned income. Anyone 50 years old or older by the end of the year can contribute $6,000. (If you are married, your spouse can contribute the same amount, based on his or her income or, if he or she does not work, you may contribute up to $5,000/$6,000 to his or her IRA.) You can fully deduct your contributions if neither you nor your spouse was an active participant in an employer plan during 2010. If one of you was a member of a plan, income limits apply. (See also: Roth IRA.) If you contribute to both a traditional IRA and a Roth, the $5,000/$6,000 contribution limit applies to the combination.

IRA custodial fees. IRA trustee or custodial fees that you pay directly out of your own pocket qualify as a miscellaneous itemized expense deductible to the extent that it and your other miscellaneous deductions exceed 2% of your adjusted gross income. If the fee is debited from your IRA, the amount cannot be deducted.

IRA loss. See Loss on an IRA.

Investment interest. If you itemize deductions, you can deduct investment interest expenses, such as margin interest paid to a broker, but only to the extent of your net investment income. Net investment income includes interest and short-term capital gains. Dividends and long-term capital gains count as investment income only if you elect to forgo the 15% maximum tax rate on them. Any disallowed investment interest in one year is carried forward to the next year and can be deducted then if you have enough investment income.

Keogh plans. You can make a tax-deductible contribution of up to 20% of your net earnings from self-employment -- up to $49,000 in 2010 -- to a Keogh retirement plan. The plan must be opened by December 31, 2010, to make a 2010 contribution but deposits for 2010 can be made as late as October 15, 2011, if you file for an extension of the due date of your return.

Long-term loss. See Capital losses.

Loss on an IRA. It is almost impossible to deduct losses suffered inside an IRA or Roth IRA. You have a deductible loss only if you close all of your traditional IRAs or all of your Roth IRAs and the total distributed to you is less than the total of nondeductible contributions made to the account. Even if you have such bad luck, you must pass another test: The loss is considered a miscellaneous expenses, deductible only if you itemize and only to the extent that all your miscellaneous expenses exceed 2% of your adjusted gross income. This is one deduction you must hope you’ll never qualify for.

Margin interest. See Investment interest.

Nominee interest. If you received interest as the nominee for another person (as you might if you and a sibling co-own a certificate of deposit, for example) and the entire amount of the interest is reported to you on Form 1099-INT, you can deduct the amount that does not belong to you when you report the interest on your return.

Non-business bad debt. See Bad debts.

New markets tax credit. This credit is an incentive for investments in entities that lend money to firms in poorer areas. Investors get a 5% credit in the first three years on the money they put up and a 6% credit for next four years.

Penalty-free withdrawals from IRAs and qualified plans. Generally, a 10% penalty tax applies if you withdraw funds from a traditional IRA or company retirement plan before reaching age 59½. There are, however, many exceptions. There's no penalty, for example, if the cash comes out of a 401(k) or other company plan after you leave your job in a year you turn 55 or older. The penalty can also be waived if the money is used to pay extraordinary medical bills, to pay for medical insurance while you're unemployed, to pay for college for yourself or your children, or to buy a first home. Check for any possible exceptions before paying the 10% penalty.

Penalty for early withdrawal of savings. If you paid a penalty to a financial institution to break a certificate of deposit, you can deduct that amount on line 30 of the 2010 1040. You can claim this deduction whether or not you itemize.

Ponzi schemes. Investors in Ponzi schemes – like the one concocted by the infamous Bernie Madoff – can deduct their loss as a theft loss, not as a capital loss. And, unlike personal theft losses, the Ponzi scheme loss does not have to be reduced by $500 or by 10% of adjusted gross income to arrive at the tax deduction. The loss is claimed in the year the loss is discovered.

Roth IRA. For 2010, you can contribute up to $5,000 to a Roth individual retirement account if you have that much earned income. Anyone 50 years old or older by the end of the year can contribute $6,000. (If you are married, your spouse can contribute the same amount, based on his or her income or, if he or she does not work, you may contribute up to $5,000/$6,000 to his or her Roth IRA.) Unlike a traditional IRA, no one can deduct contributions to a Roth IRA. But, although withdrawals from traditional IRAs are taxable in retirement, withdrawals from Roth IRAs are tax-free. If you contribute to both a traditional IRA and a Roth, the $5,000/$6,000 limit applies to the combination of your contributions.

Safe-deposit box fees. If you use a safe-deposit box to store your investments, the fee is deductible as a miscellaneous expense to the extent that it and your other miscellaneous deductions exceed 2% of your adjusted gross income.

Saver's credit. Low-income taxpayers who contribute to an IRA or company retirement plan may qualify for this tax credit worth up to 50% of the first $2,000 contributed.

Savings bonds cashed in for education. Interest on EE savings bonds bought after you turned 24 can be excluded from your income if the proceeds are used to pay for college for you, your spouse or a dependent. This break gradually phases out for 2009 2010 as income rises above $69,9571,1000 on single returns and above $104,900105,100 on joint returns.

Short-term loss. See Capital losses.

SEPs. Self-employed taxpayers can deduct contributions to a Simplified Employee Pension (SEP). The maximum contribution is the smaller of 20% of net earnings from self-employment or $49,000 in 2010. (The $49,000 cap will also apply for 2011.) Contributions are due by April 15, 2010, but you can extend the due date to October 15, 2011, if you file for an extension of the due date for filing your tax return.

SIMPLEs. Small-business owners can also choose a SIMPLE plan for their retirement savings, which stands for Savings Incentive Match Plan for Employees. For 2010, deductible contributions are limited to $11,500 ($14,000 if you're 50 or older by year end) plus 3% of self-employment income. SIMPLE plans generally have to be set up by October 1 of the first year for which you want to make contributions.

Spousal IRA. Generally, to contribute to a traditional or Roth IRA, you must have income from a job or self-employment. But, a working spouse can contribute up to $5,000 of his or her earned income to an IRA for a non-working spouse. The limit is $6,000 if the non-working spouse is age 50 or older by the end of the year.

Stepped-up basis. If you sold property you inherited, be sure you take advantage of a rule that saves taxpayers billions of dollars each year. The tax basis of inherited assets -- such as stocks, bonds, mutual funds and real estate -- is generally the assets value on the date of death of the previous owner. The tax on all appreciation while he or she owned it is forgiven. This rule does not apply to inherited retirement plans; if you inherited such a plan, you are taxed on withdrawals just as the original owner would have been. NOTE: A special rule applies for assets inherited in 2010. For the vast majority of taxpayers, the basis of inherited property will be stepped up as discussed above. However, as part of the deal to reinstate in estate tax retroactively to January 1, 2010, Congress gave executors of estates the right to avoid the estate tax (and the automatic step-up of basis) and instead choose the rules that were to be in effect for 2010. Under that scheme, there was no estate tax regardless of the size of the estate, but there was a limit on stepping-up basis. No more than $1.3 million of gain could be wiped out (plus an extra $3 million on assets left to a surviving spouse). Heirs not protected by that rule would receive “carryover basis”, meaning that when they sell property inherited in 2010, their tax bill would be based on the tax basis of the original owner. Tax on profit that built up during his or her lifetime would be taxed to the heir. Again this will apply to very few people—those who inherited property from estates with appreciation exceeding $1.3 million (plus the spousal allowance).

Travel to see your broker. If your trip is just to check on the market, there's no tax deduction. But if you visit your broker to discuss your specific investments, you can deduct 50 cents a mile for visits during 2010, plus the cost of parking and tolls. This is a miscellaneous expense, deductible to the extent all your miscellaneous costs exceed 2% of your adjusted gross income. (The per mile rate rises to 51 cents a mile for 2011 driving.)

1244 losses. You can claim favorable tax treatment for stock in corporations that are capitalized with less than $1 million. Joint filers can deduct up to $100,000 of loss incurred on such stock as an ordinary loss. Other filers can deduct up to $50,000 of loss. The loss is not subject to the usual $3,000 cap on excess capital losses. The corporation must be involved in an active trade or business such as manufacturing or mining for its stock to qualify for this treatment.

Worthless securities. If you owned securities that became completely worthless during the year, you claim a loss as if you had sold the securities on December 31 for $0.

See our other taxopedias.