Top 10 Tax Mistakes Investors Make

Are you helping your clients avoid these common blunders?

Investing is a complex undertaking. The supply of investment alternatives is seemingly endless. Evaluating various alternatives can be quite difficult and very time consuming. And unless held in check, the actual decision-making process is fraught with human emotions that often lead investors to make counterproductive investment choices.

With that in mind, John Burke, CFP, president of Burke Financial Strategies, and Steven Criscuolo, CPA, chief financial officer of Burke Financial, put together this list of the top 10 tax mistakes made by investors through a recent survey conducted of investment advisors.

1. Short-term vs. long-term gains 1. Short-term vs. long-term gains

Realized gains on appreciated securities held for one year or more qualify for favorable tax treatment. Long-term capital gain tax rates are significantly lower than short-term rates. Holding a security an extra day, week or month can significantly reduce the tax burden.

2. Foreign stock investments held in a tax-qualified account 2. Foreign stock investments held in a tax-qualified account

Most foreign companies are required to withhold foreign taxes on dividends paid. U.S. investors can claim a tax credit on their tax returns, effectively recouping this lost dividend -- but only if the foreign stocks are held in a taxable account.

3. Gold and silver held in a taxable account 3. Gold and silver held in a taxable account

Gold and silver are treated as collectibles and therefore are not eligible for capital gains treatment. The federal tax for long-term gains on collectibles is 28 percent.

4. Sale of appreciated securities by elderly investors 4. Sale of appreciated securities by elderly investors

The cost basis of appreciated securities is “stepped up” to the current market value upon the death of the owner. Prospective capital gains and related taxes disappear. Conversely, all prospective capital losses will be lost. Elderly investors should consider being quick to sell stocks with losses and slow to sell stocks with gains.

5. Generating excess unrelated business income in a tax-qualified account 5. Generating excess unrelated business income in a tax-qualified account

Certain investments, such as Master Limited Partnerships, generate unrelated business income. These investments belong in a taxable account. If they are held in an IRA or other qualified plan, and if the Unrelated Business Taxable Income, or UBTI, is greater than $1,000, then the investor must complete and file a rather complex Form 990 and pay additional income tax.

6. Ignoring local tax laws 6. Ignoring local tax laws

In some states, investors cannot carry capital losses forward to future years. On a federal return, a capital loss in one year can be used to offset gains in a subsequent year. But capital losses without offsetting gains in a current year are lost for state tax purposes.

7. Failing to consider a Roth IRA conversion 7. Failing to consider a Roth IRA conversion

When a traditional IRA is converted to a Roth IRA, tax is due on the converted amount in the year of conversion. If, for whatever reason, an investor will have low income in a year, this is an ideal time to convert and settle the tax bill on this money at a significantly lower rate than is otherwise expected in the future.

8. Failing to realize capital gains 8. Failing to realize capital gains

Once again, low income in a given year can provide an opportunity to save taxes. Long-term capital gain tax rates are progressive; rates increase as taxable income increases. For taxable incomes up to $72,500, joint taxpayers pay no tax on long-term capital gains.

9. Improperly calculating the cost basis for MLPs 9. Improperly calculating the cost basis for MLPs

Given their unique tax structure, a large portion of a typical distribution from a Master Limited Partnership (a form of publicly traded limited partnership that’s most commonly related to natural resources, like oil and gas extraction) is tax-free. This tax-free distribution is considered a return of principal and should therefore serve to reduce the cost basis. In this case, ignorance may be bliss because the reduction in basis would result in a higher capital gain at sale (unless the IRS comes knocking…).

10. Allowing a pension plan to become non-compliant 10. Allowing a pension plan to become non-compliant

While not as common as the others, this mistake can be very costly. There are a number of actions or inactions that can put a plan’s qualified status in jeopardy. Oftentimes, an investor will establish a plan with a brokerage firm, and then assume that the brokerage firm is taking care of the ongoing regulatory requirements, including the filing of IRS Form 5500. Brokerage firms rarely do this, even though they may have provided the original plan document template. Failure to meet ongoing regulatory requirements can result in disqualification of the plan and a very large tax bill. Investors should consider hiring a third-party administrator to take care of their ongoing compliance obligations.



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