It used to be that only the rich had to worry about capital gains. Today, with more and more average Americans investing everyday, capital gains have become more and more a part of our everyday language. The tax rate from the capital gains tax schedule that applies to your client depends on the type of asset they sold, their cost basis, the length of time your client held the asset before selling it and their income level. The lower rates apply to stocks, bonds, mutual funds and other capital assets. Business and rental real estate, depreciation and collectibles are taxed at a slightly higher rate.
It is of great importance for your client to understand and calculate their cost basis correctly. While the value of your client's equity is the price they paid for their stocks, it is not the number they should report on their tax return. The number that goes on their tax return is the value of the equity of their stock minus any costs incurred in carrying out the transaction. That means your client should subtract the commission they paid to their broker, or other such costs, in order to figure their cost basis. Take a look at how calculating your client's cost basis affects their reporting of gain. If your client bought 100 shares of stock at $50, the value of the stock is $5,000. If they paid a $100 commission to their broker, which means their cost basis is now $5,100. If your client sells all of the shares when they hit $100, their proceeds for the sale will be $10,000, less the $100 paid for commission. That brings their net proceeds down to $9,900. Therefore, instead of reporting a $5,100 gain, your client will report a $4,900 gain and that's a $200 dollar difference. If your client would have had to pay 20% tax on that $200, then he/she saved $40. The forty dollars may not seem like much, but it all adds up, especially if your client is a big trader and/or pays out a lot of money in commissions.
Most brokers deduct the commissions paid from the proceeds and therefore the net shown on their Form 1099-B should be reported as sale proceeds. However, some brokers do not deduct from the proceeds and therefore they must add the commission to the basis they report on Schedule D. Make sure your client checks the 1099-B forms they receive. A checkbox on the form will indicate which way the brokerage is reporting its commissions. Its important for your client to get it right because the government is also sent a copy of the Form 1099-B they have received and will compare it to their reporting on Schedule D. Discrepancies could potentially cause trouble.
There are two holding periods for capital assets sold on or after January 1, 1998. Assets held for more than one year are considered long term while those held for less than a year are considered short term. If your client is in the 15% tax bracket and their assets have been held for less than a year, they are taxed at the ordinary tax rate. However, if their assets have been held for more than one year, they will only be held at the 10% rate. The same holds true for those of your client in a tax bracket greater than 15%. Assets held for less than a year are taxed at the ordinary income tax rate while those held for more than one year are taxed at a 20% rate.
