Toting Up Capital Gains and Losses
December 12, 2001
One of the most important things taxpayers can do this time of year to minimize their tax bite is realize some capital losses. They also need to pay close attention to their mutual funds, because fund managers have a lot to say about whether fund investors have taxable gains or losses for the year.
Capital gains and losses are treated asymmetrically. While all net gains are taxed, the deductibility of losses is limited.
- Under current law, taxpayers first deduct any short-term gains -- on assets held less than a year -- against short-term losses.
- Net short-term gains are taxed like ordinary income at rates up to 39.6 percent.
- Similarly, long-term gains, those over one year, are netted against long-term losses and taxed at a maximum rate of 20 percent.
- After this, net short-term losses are used to offset net long-term gains, and if an investor has an aggregate loss, up to $3,000 of it can be deducted from ordinary income.
The most important problem with this system is that it discourages risk-taking. Economists have long argued that capital losses should be fully deductible against ordinary income. Investors are going to have a lot of losses this year. The combined value of stocks on the New York Stock Exchange is down $1.5 trillion since January 1, and the NASDAQ is down another $1.1 trillion.
The law allows taxpayers with excess losses to carry them forward to future years, but that makes them much less valuable than those that can be deducted immediately.
Mutual fund investors can often find themselves with taxable gains even when the value of their funds has fallen, because all realized gains and losses on stocks owned by mutual funds are attributed directly to fund investors.
If fund managers realized a lot of gains this year, but held on to losses, investors could find themselves with big tax bills even though they lost money.
Source: Bruce Bartlett, senior fellow, National Center for Policy Analysis, December 12, 2001.
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