Taxes Q&A: We Answer Your Questions

by the Schwab Center for Financial Research
March 10, 2009

Each month, we receive thousands of questions from Schwab clients. Here, we tackle the top questions on taxes, with answers and guidance that we believe will address some of your most pressing concerns.

If you have a question that doesn't appear below, we have more Q&As on timely topics in the box at right. If you have a question that we haven't already addressed, you can submit it using the Editor Feedback form at right—we may include it when we add new questions and answers.

To talk to a Schwab investment professional about your particular circumstances, please call 800-435-4000.

On taxes

What kind of tax credit will I get if I sell some long-held, but now big-loser stocks? How much will it offset taxes I may owe?
I had to pull my funds out of my portfolio a couple of months ago so I could apply them to the purchase of my first home. Can the tax obligation be spread over the next 10 years?
How do I decide which stocks to sell to take advantage of capital losses for tax purposes?
We've all heard that the Obama administration plans to cancel a lot of the Bush tax exemptions. What about the zero tax on capital gains through 2010 for singles making $32,550 or less? If I knew this item would be canceled in 2009, should I sell some stock with gains this year?
What are good sources to find out about new tax laws?
What's your opinion on the possibility of an increase in the tax write-off amount for excessive losses?
Do you think the Obama administration and Democratic Congress will raise capital gains and corporate taxes in such a volatile market? If so, when will the changes go into effect?
Any chance that capital gains taxes will be lowered temporarily?
Can I contribute to a 401(k) after the age of 70½ if I'm still working full time? Conversely, am I still required to take a minimum distribution from my 401(k) if I'm working full time?

What kind of tax credit will I get if I sell some long-held, but now big-loser stocks? How much will it offset taxes I may owe?
Capital losses—securities sold for less than the original purchase price—can be used to offset capital gains on your tax return, as long as the loss sale occurs in a taxable account.

In addition, if your capital losses exceed your capital gains in any year, up to $3,000 can be used to reduce your taxable income (up to $1,500 each for married persons filing separately). Any losses still left over are available for use in future years, without expiration. For more, see "Get a Tax Break by Harvesting Losses."

I had to pull my funds out of my portfolio a couple of months ago so I could apply them to the purchase of my first home. Can the tax obligation be spread over the next 10 years?
Two new tax provisions are now in place regarding the purchase of a first home in 2008 or 2009, and they are very different. It's literally all about the timing of your home purchase.

First, a new tax credit of $7,500 was included in the Housing and Economic Recovery Act of 2008. The credit applies only to home purchases after April 8, 2008, and before December 31, 2008, and reduces a taxpayer's tax bill or increases his or her refund, dollar for dollar. The credit is also fully refundable, meaning that it will be paid out to eligible taxpayers even if they owe no tax or the credit is more than the tax that they owe. However, the credit operates much like an interest-free loan, because it must be repaid over a 15-year period.

So, for example, an eligible taxpayer who bought a home last fall and properly claims the maximum available credit of $7,500 on his or her 2008 federal income tax return must begin repaying the credit by including one-fifteenth of this amount, or $500, as an additional tax on each tax return beginning with the 2010 return and going forward for 15 years.

The credit is phased out based on your modified adjusted gross income (MAGI), which is your adjusted gross income plus various amounts excluded from income—for example, certain foreign income.

For a married couple filing a joint return, the phase-out range is $150,000 to $170,000. For other taxpayers, the phase-out range is $75,000 to $95,000. This means the full credit is available for married couples filing a joint return whose MAGI is $150,000 or less, and for other taxpayers whose MAGI is $75,000 or less.

A second first-home tax incentive was included in the economic stimulus package signed into law by President Barack Obama in February. This one applies to individuals who purchase a home between Jan. 1 and Dec. 1, 2009. It's an $8,000 tax credit, but unlike the previous example, this credit does not need to be repaid. It's a true tax credit, not a deduction.

Individuals who purchased homes in January or February 2009 can claim this credit on their 2008 tax return by filing IRS Form 5405. Like the 2008 tax credit, this tax incentive phases out for individuals whose MAGI is above $75,000 or for couples above $150,000.

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How do I decide which stocks to sell to take advantage of capital losses for tax purposes?
We recommend selling stocks rated D or F by Schwab Equity Ratings that provide you with a capital loss (which provides more favorable tax treatment).

Selling A- or B-rated stocks is not recommended if you have lower-rated stocks in loss positions. But swapping one highly rated stock for another may be effective if your tax savings can cover the round-trip transaction costs of the trades.

One note of caution: Be careful of the wash sale rule, which disallows losses on stocks if they are replaced by "substantially identical securities" within 30 days before or after the sale that realizes the loss. You should consult your tax professional for advice prior to the sale.

To see the current rating for a particular stock, clients can log in to Schwab.com, type in the stock's ticker symbol, click Go, and then click the Schwab's Viewpoint tab. And for more information, see "Tax Considerations for Selling a Stock."

We've all heard that the Obama administration plans to cancel a lot of the Bush tax exemptions. What about the zero tax on capital gains through 2010 for taxpayers in the 15% ordinary bracket? If I knew this item would be canceled in 2009, should I sell some stock with gains this year?
So far, there has been no proposal to eliminate lower long-term capital gain rates for lower-income taxpayers. Even if the lower rates are allowed to expire after 2010 as scheduled, for most taxpayers it would only make sense to sell before Jan. 1, 2011, if you were planning on a near-term sale anyway.

After 2010, the long-term capital gains rate would only go back to 20% for securities held more than one year and 18% for securities held more than five years (per pre-2001 law), versus the current maximum rate of 15%. If you're in it for the long term, why sell to save 3%–5% on capital gains taxes if you're going to turn around and reinvest the money anyway?

From a historical perspective, keep in mind that long-term capital gains were taxed at 28% up until 1997, during the greatest bull market of all time, and then at 20% up until 2003. It would be nice if the 15% and 0% rate categories were made permanent (if there ever could be such a thing as "permanent" when it comes to tax law). But, for long-term investors with decades of investing ahead of them, going back to 20% doesn't seem like something that should, by itself, trigger a sale.

On the other hand, if you are eligible for the 0% rate then it would make sense to take advantage of it while you can, at least for the eligible amount based on your filing status and other taxable income. Regardless of your tax status, remember that the investment decision should always come first.

What are good sources to find out about new tax laws?
You can check out the Tax page on Schwab.com, as well as the articles in our tax library. Schwab clients can log in to their accounts to access even more information and tools, including CCH's Complete Tax online projection and return filing software and tax library. Just select the Guidance tab and then click on Taxes.

The ultimate authority on tax law is the U.S. Treasury's Internal Revenue Service (IRS). You can find a lot of great information on the IRS Web site, including news, official forms, instructions, publications and more.

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What's your opinion on the possibility of an increase in the tax write-off amount for excessive losses?
You're referring to the rule that says if your capital losses exceed your capital gains in any year, up to $3,000 of the remaining capital losses can be used to reduce your taxable income (up to $1,500 each for married persons filing separately). Any losses still left over are available for use in future years, without expiration.

Lately, there's been increasing chatter in Washington about a proposal to increase the amount of capital losses that can be deducted, but to date it hasn't gained real momentum. During debate over the economic stimulus bill in early 2009, an amendment was proposed to increase the limit on capital losses that can be deducted from $3,000 to $15,000.

The amendment was defeated during the Congressional committee process, but a key committee chairman expressed support for the idea, and promised to take a harder look at the proposal later in 2009. While we continue to believe that the odds are low that such an increase will occur this year, there is increasing attention being paid to the idea in Congress. We will continue to monitor this as the year progresses.

Do you think the Obama administration and Democratic Congress will raise capital gains and corporate taxes in such a volatile market? If so, when will the changes go into effect?
President Obama's budget proposal, released in late February 2009, shed some new light on his thinking with regard to taxes. While the budget is still only an outline, and ultimately Congress will have to hammer out the details, it providing a useful sense of what the President's tax priorities will be in the coming debate.

With regard to taxes on capital gains and dividends, the President's budget proposal calls for an increase in the rate from 15% to 20%, beginning in 2011, only for individuals in the top two tax brackets. According to the budget, that would generally include only people whose incomes exceed $200,000 for individuals or $250,000 for couples.

The budget proposal does not increase the tax rate on capital gains and dividends for individuals in lower tax brackets. The rate would remain at 15%, or 0% for those in the lowest tax bracket. It is important to note that some in Congress continue to advocate for an across-the-board 20% capital gains rate, and this may be a proposal that comes up when Congress begins debating the budget. But the strong signal from the White House is that the President prefers to increase the rate only for wealthier individuals.

We continue to believe the volatile state of the economy makes it unlikely that the capital gains tax rate will increase prior to the end of 2010.

Any chance that capital gains taxes will be lowered temporarily?
While several Republicans in Congress advocated this as part of an economic stimulus package, a temporary reduction in capital gains taxes never gained any real momentum and does not currently appear to be on the table.

Can I contribute to a 401(k) after the age of 70½ if I'm still working full time? Conversely, am I still required to take a minimum distribution from my 401(k) if I'm working full time?
You should be able to contribute to a qualified employer plan regardless of age as long as you're still working there, but check with your plan administrator to be sure. Additionally, as long as you have earned income and are under 70½, you can also contribute to a traditional IRA. (Whether the contribution is deductible or not depends on your income if you're also an active participation in an employer-provided plan.) There are no such age restrictions for Roth IRAs.

Working past age 70½ does not affect the required minimum distribution (RMD) rules for traditional IRAs—RMDs are still required whether working or not. (There are no RMD requirements for Roth IRAs.) However, the rules for qualified employer plans, such as 401(k)s, are different.

If you continue to work past age 70½ (and do not own more than 5% of the business you work for), you should be able to postpone RMDs from your current employer's plan until after you retire (no later than April 1 of the year after retirement). Be sure to check with the plan administrator, as employer rules may vary.

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Important Disclosures

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

This information is not intended to be a substitute for specific individualized tax, legal or investment planning advice. Where specific advice is necessary or appropriate, Schwab recommends consultation with a qualified tax advisor, CPA, financial planner or investment manager.

The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.

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