Figuring out capital gains and losses for the tax year is something that everyone who invests must go through. But does it really have to be so confusing? Not really. The trick here is to net your clients long term gains and losses separately from their short-term gains and losses. Long-term gains and losses result when investments are held for over one year and short-term gains and losses result when investments are held for less than a year. Then when you are done figuring out your clients long term and short term gains and losses, they can either add the two or subtract one from the other to figure out their capital gains and losses for the year.
If your client had only long-term gains for the year, they get taxed at 20% or less depending on their tax bracket. The 20% rate is applied for the 28% tax bracket. Short-term gains are taxed at your clients ordinary income tax rate, which is 39.6% or more. There is not much to figure out when they only have either short or long term gains. But what if they have both short-term losses and long term gains? You can write off as much of the losses as the gain. Here is an example: This year Jake accrued $6000 in long term gains and $8500 in short term losses. Subtract his losses ($8500) from his gains ($6000). The result is that Jake has $2500 in net losses (-$2500). The IRS offers him a break here giving him the opportunity to write off as much as $3000 in losses against ordinary income. So for the remaining $2500, Jake gets a deduction.What if all you had were losses? This is where it gets a little tricky. You need to offset your clients short-term losses first, before you do thier long-term losses, using the $3000 max deduction the IRS has set. The remaining losses get carried over to the next year. But what if your client had long term losses and short term gains on their investments? First you have to figure out which is bigger. If the short-term gain is bigger, your client just pays ordinary income taxes on the gain. If the long-term loss is bigger, your client can write off as much as $3000. If there is still some remaining losses after that, they can be carried over to the next year.
The lesson to be learned here is always advise your client to dump his or her losing short term investments by December 31st, especially if their long term gains are higher. This way they get a deduction for whatever loss they had and they pay taxes in the 20% rate compared to 39.6% rate on their gains. However, if your clients short-term gains are larger, advise them to dump some of their long-term investments that are losing money for them. This way they can offset some of the tax they will pay on the gains.