A Hedgehog Commentary

Tax Tips

12/19/97 - As we come to the end of the year, I thought I'd pass along a few tax tips. Now, the Hedgehog isn't a tax expert, so if you decide to use any of these, be sure to check into the details with the IRS, your tax advisor, or a tax guide. This commentary won't help you much in an audit.

Most of these tips have been culled from Money magazine.

The new capital gains law reduces significantly your taxes on gains from assets held longer than 18 months (taxes are reduced even more for assets held longer than 5 years after the year 2001). If the current market has you nervous and you wish to lock in gains on assets held less than 18 months, you can buy put options to lock in your price. Put options give you the right to sell your shares at a set price until a predetermined future date. A potentially less expensive possibility is to sell short the exact same number of shares. If the price drops, the short position gains match your losses on the long side. Once 18 months have passed, you can close out the position. The downside to shorting is that you can only hold the position for 4 months before the IRS requires you to close it out (new changes in the tax law may even further weaken this option so check before trying).

If you own both growth and income producing mutual funds, consider putting the growth funds in your taxable accounts and your income funds in your tax deferred accounts. This way the higher tax rate income funds are protected while the capital gains on the sale of the growth funds will be taxed at the lower capital gains rate.

If you plan on selling mutual funds, make sure you do it before the fund reports end of year capital gains in December. These gains would be taxed as ordinary income instead of the lower long term tax rate that you would receive if you've held the fund more than 18 months. On the converse side, don't invest in a mutual fund until after it makes distributions. The net value of your account will remain the same since the effect of the distribution is to reduce the value of each fund share but you'll now have taxable income to report.

If you're paying college tuition, consider trying to put off payments for next semester until next year. The new Hope credits for college tuition go into effect next year and you can use those payments toward obtaining credit.

It is almost certain that everyone will want to put some money into an IRA (probably as much as you can). What type will depend on your financial sitution. Everyone can use a non-deductible IRA. The deductible IRA is now available for those couples making under $50K (singles under $30K). The new Roth IRA is available to couples making under 150K (singles under $95K). The Roth IRA is a great deal for those who can't use a deductible IRA as the gains are never taxed and there is no age requirement on when withdrawls must be made. For those that can use either the deductible IRA or the Roth IRA, the decision will depend on your age and what you expect to be earning in retirement.

Another decision to make will be on whether to convert existing IRA's to Roth IRA's (for those making under $100K, singles or couples). If you do, you'll have to pay taxes on any amounts you deducted and on any sheltered earnings; you can spread payment out over the next four years. The decision will again depend on age, your planned earnings in retirement, and whether you pay the taxes out of the IRA or from other funds (which is what you should do if you decide to convert). There are calculators available to help with these decisions (try FinanCenter on our links page).

Another change in the IRA laws allows a non-working spouse to contribute as well.

While you can wait until April 15, 1999 to make your 1998 IRA contribution, put it in as early in 1998 as possible to maximize the amount of your earnings that are tax deferred.

An addendum to last week's commentary on the hawking of questionable stocks over the internet This week's (12/15/97) issue of Business Week looks at the selling of junk stocks by crooked dealers with the collusion of paid off analysts.