January 2024,
For the past couple of months, I have been telling my clients that they owed money or would be receiving a smaller refund on their 2021 tax return. The reason for this change in my client’s tax picture … 2021 was a great year to be invested in the stock market. While none of my client’s disagreed with that statement, I realized many of them did not fully understand how the changes in the stock market affected their tax picture. Question – how do changes in the stock market affect someone’s tax return?
A change in the value of someone’s investments does not necessarily have an impact on your taxes. This is because the change is the value of someone’s investments is made up of a couple of components. Let’s begin with the two most common and always taxable components called interest and dividends. If you receive interest or dividends from a bank, broker, credit union, a stock, a bond a mutual fund or any other financial instrument or institution, you will owe tax in the year that you received the interest or dividends. The entity paying you the interest or dividends will issue you a Form 1099 stating how much interest/dividends they paid you that year. An exception to this is if you earn less than $10 of interest from your bank, the bank is not required to send you a Form 1099 at the end of the year.
The other two components are realized and unrealized gains and losses. Realized gains/losses are when a security that you own is sold for a gain or loss. Realized gains are fully taxable in the year that the security is sold. Realized losses are limited to offsetting any realized gains. If the realized losses exceed the realized gains in any given year, you are allowed to deduct $3,000 of realized losses against the rest of your income. If your realized losses exceed $3,000, they will be carryforward indefinitely until they have been utilized.
Unrealized gains/losses are when your investments increase/decrease in value which changes in the market. Say you purchased 100 shares of Amazon for $1,000 per share. At the end of 2021, these shares would have been worth $333,434. You would have an unrealized gain of the shares of $233,434 ($333.434 proceeds of sale less $100,000 cost of shares). This amount is not taxable until you sell the shares. If you had purchased 100 shares of Amazon on December 31, 2021 for $333,434, those share would be worth $230,293 as of May 27, 2022. This would give you an unrealized loss of $103,141 ($230,293 market value less $333,434 cost of shares). This loss is NOT tax deductible, because you have not sold the shares.
How do you minimize your tax bite? Instruct your broker or investment adviser to always sell the shares with the smallest gain. Although it may not be practical, you can avoid dividend paying stocks. These will help keep your taxes lower. If you own mutual funds, be aware of their tax efficiency. You can speak to your broker, investment advisor or read the prespectus for any mutual funds you own.
No one likes to see their investments decline in value, but the current market down turn may provide tax planning opportunities. Consult your tax adviser
Wagner Shields & Moini LLP | www.wsmcpas.com
