Sometimes, understanding the difference between your overall return for the year and your taxable gain for the year can be a bit confusing. WT Wealth Management creates portfolios with a diversified mix of assets. In addition, during the year, we may have sold some of the assets to create an asset balance that we think is appropriate. Some of these assets have probably gained value and some of them may have gone down in value. At the end of the year, we then work to minimize your taxes owed. We may decide to sell some assets that have experienced a loss during the year to offset some of the assets we may have sold during the year that experienced a gain. Other assets we will continue to hold in the coming year. By selling some of the losing assets, we can often make it so that you owe less to the IRS.
Understanding the Numbers on Your 1099 Form
The gains or losses on your 1099 tax statement from Schwab (or any asset custodian) for last year are not your actual total portfolio gains for the year. Your gain for the year can be found by comparing the total account value at the end of the year with the account value at the beginning of the year. Of course, you need to adjust for any withdrawals or contributions you may have made during the year.
Working Through an Example
Assume that you start the year with $300. You have $100 in each of three assets: A, B and C. At year end, asset A is up 20% to $120. Asset B is down 10% to $90 and asset C is up 30% to $130. Your total asset value is now $340 (the total of the three asset values: $120 + $90 + $130). You had a fairly good year with a gain for the year of $40 ($340 less the beginning value of $300). This is an annual return of 13.3%.
What Might Happen Near the End of the Year?
Let’s say you sell asset A for a $20 gain and asset B for a $10 loss. This is a net gain of $10. You do not sell asset C because you still like the asset, so no tax is currently owed on the $30 increase. Your Schwab account will report a $10 taxable gain, which is only 3.33%. But remember, you actually gained 13.3% for the year.
What is the tax impact of deferring gains?
Let’s assume you have a tax rate of 25%. This means that you owe 25% of the $10 gain that you realized for the year. This means that you will owe the government $2.50. But you have not sold asset C, so it remains in your portfolio with an unrealized gain of $30. Taxes on this gain can be deferred until you actually sell asset C in the future. If asset C had been sold, you would have owed $7.50 on that gain. By not selling asset C you keep the $7.50, for now, and it will continue to work for you.
What Causes Confusion
Every year we get calls from clients who are wondering why the 1099 tax statement from Schwab shows a gain that is less than they believe they earned. The 1099 from Schwab, for the example above, shows only the net gain of $10 from the assets that you have sold. At first glance it may appear that you only made $10 for the year, or a 3.3% gain. But the 1099 does not show the unrealized gain of $30 on asset C. So, for the year you actually earned $40 or 13.3%.
At WT Wealth Management, we intentionally take steps to keep the taxes you owe as low as possible. FBN
By Allen Atkins
Dr. Allen Atkins is a local investment advisor at WT Wealth Management located at 809 W. Riordan Road, Suite 206 in Flagstaff. He is also a professor of finance. You can contact Dr. Atkins for a no-cost consultation at 928-225-2474 or at [email protected].