Screwy tax law?

[KTP]

I will make this very very simple, but correct me if I am wrong here.

Company Widgets gives me a stock grant bonus of 1000 shares of stock at a current price of $50. This is reported as ordinary income on my W2 ($50,000 increased income). April rolls around and I pay about 34% of the 50,000 in taxes out of my other money ($17,000)

I decide I am going to hold the stock for a year in order to pay long term capital gains. During the year the market for widgets goes to pot and my company share price plummets to $10. I sell the 1000 shares for $10,000 and realize a $40,000 loss.

Ok, so I have paid a tax of $17,000 on $50,000 worth of stock that I sold for $10,000. I am out of pocket $7,000. I decide from this bad experience never to invest in the market again. I have no other capital gains to offset the loss.

I am floored to find out that I can only deduct $3,000 of my $40,000 loss against my ordinary income! I think I can carry foward the loss indefinately, but at this rate it would take over 13 years to recoup the amount of over tax that I paid uncle sam!

Is my logic totally screwed up here or is this the way the system works? If this is the case, it should be recommended to EVERYONE to immediately sell any stock grants you get that are taxed as ordinary income. A situation like this has developed with me, although not quite as drastic as the scenario I laid out because I will probably have capital gains in the future if the markets recover.

[MonkeyMama]

Yup, that about sums it up.

I am a tax professional and I have said a few times, that this pretty much sums it up: "If you make any kind of income, anyhow, you have to report it. But if you have a loss, you don't get to deduct it."

Over simplisitc, but it is the philosophy of most of the tax code. Most losses can be carried forward to offset income. So you are lucky you get to take $3k per year in this case.

[KTP]

and nobody in the "business" thinks that this is totally unfair?

it would seem to me that in an extreme case, say where you were granted hundreds of thousands of dollars of a start-up stock which then crashed and burned (and don't say this hasn't happened), you could end up owing the government so much money you could never pay it off.

[MonkeyMama]

and nobody in the "business" thinks that this is totally unfair?

it would seem to me that in an extreme case, say where you were granted hundreds of thousands of dollars of a start-up stock which then crashed and burned (and don't say this hasn't happened), you could end up owing the government so much money you could never pay it off.

Yes - of course that has happened!

Did I say taxes were fair? Teehee!

Hey, I just help people figure out the rules. I am not a legislator. Your time would be far better spent writing a letter to your legislators. (& I wish more people would, there is only so much we can do to fight for taxpayers' rights when they don't even know what is going on to fight for themselves).

[KTP]

Oh I wasn't complaining at you. I know you didn't write the tax laws and I appreciate the time you spent confirming my scenario.

What I would like to see is more people informed that this is the way the law works. We had nobody recommend that we immediately sell any stock grants as they became vested...on the contrary, everyone recommended holding them for at least a year and a day to take advantage of the cheaper long term capital gains rate.

I now would recommend to everyone, regardless of how you feel about your company, to immediately sell any company stock as soon as you can after it is vested. Set aside the exact amount that you will owe in taxes and wait 30 days. After 30 days you can re-buy the company stock if you so choose. In this manner you will never encounter a tax liability greater than the amount of money you actually received.

I wish someone had told us this a number of years ago...

[simpletron]

your employer has to withhold the estimated taxes from your paycheck or require you to pay extra withholding(depending on size of award), so you don't fall to far behind. if you don't have the cash on hand to pay the extra withholding then you can sell the stock you just received, which probably hasn't changed much. so your scenario is less likely than you think. it generally happens to non-employees who forget to pay the estimated taxes they are suppose to pay on the award.

your employer also has the chance to give the stock award and pay the taxes on it, and the taxes on the tax on the award and the taxes on the tax on the tax on the award, ....

[wnlbutterfly]

Just remember that it is Congress that comes up with this stuff. I did taxes for a guy that played at day-trading. I say play because he had lost so much money it was unbelievable. I think he will be taking a write off in the next life time too. And this was before the stock market plunged!

[zetta]

I got hit with almost this exact scenario in 2000 (although mine was exercising stock options rather than receiving a stock grant), and ended up owing the government $40,000 that year. The good news is that you can slowly get the money back by filing the AMT tax forms -- the more expensive version of TurboTax will do it for you. I don't totally understand it, but in years that I don't owe any AMT tax I get up to $5,000 tax credit, and when I do owe AMT I recoup much more.

I absolutely agree not to take any chances with options or grants -- sell immediately and get the cash!

My employer didn't withhold any extra when I exercised my options -- I don't think they are required to in that scenario.

[Taxplanr]

You can only carry forward the loss for 20 years. Selling your stock grants is the easiest step, however you could purchase put options to protect against market declines. This may leave you room for market gains and long term capital gains treatment.

[MonkeyMama]

You can only carry forward the loss for 20 years. Selling your stock grants is the easiest step, however you could purchase put options to protect against market declines. This may leave you room for market gains and long term capital gains treatment.

Capital losses carry forward until you die.

Yeah, I have a few clients with six figure losses. However, they are young. I am sure there will be gains in their future, someday, but for now they are discouraged.

Stock options are a weird animal. It's really the only thing I Can think of that you pay taxes on before you receive the income. & I have no idea why this has not been "fixed." It has been a source of outrage for a long time, but affects such a small part of the population, that the government could care less. Ironic since it does affect a wealthy part of the population (As well as less wealthy). But clearly doesn't affect the wealthy ones with political clout.

BTW, the $3k figure is from the 70s, and has never been indexed for inflation. As with many things in the tax code. In the long run, it's a "Phantom tax."

[disneysteve]

the $3k figure is from the 70s, and has never been indexed for inflation. As with many things in the tax code.

Bingo! That's the problem. This is the same reason the IRA contribution limit was stuck at $2,000 for 20 years. This is the same reason that AMT now effects millions of Americans which was not it's intended purpose. What is so difficult about realizing when a new rule is put into place that the actual dollar amount is going to have to adjust over time? You would think that the financial guys creating these things would think of that, especially after so many examples of them forgetting to do so. They just don't learn from their mistakes.

[MonkeyMama]

Bingo! That's the problem. This is the same reason the IRA contribution limit was stuck at $2,000 for 20 years. This is the same reason that AMT now effects millions of Americans which was not it's intended purpose. What is so difficult about realizing when a new rule is put into place that the actual dollar amount is going to have to adjust over time? You would think that the financial guys creating these things would think of that, especially after so many examples of them forgetting to do so. They just don't learn from their mistakes.

Actually, they know exactly what they are doing. It's a way to "raise taxes" without people realizing. When they negotiate new laws, they are more likely to pass if there is no indexing.

& now as a lot of these things get out of hand, the government can't afford to fix it. Which is precisely what is going on with AMT. The government admits it screws a lot of people over (particularly families on the coasts). BUT, they can't afford to fix it, so oh well...

[disneysteve]

Actually, they know exactly what they are doing. It's a way to "raise taxes" without people realizing.

Sad but true. It is just like food manufacturers keeping the price of their product the same but making the package 1 oz smaller.

[marvholly]

Some state tax laws are just as ridiculous.

In IL we just changed 9/1 from bag/bars of candy being taxed as the lower food rate (2.25%) to the higher non-food rate (10.25%). yougurt cover raisins are NOT food but Good n Plenty is because it "contains flour."

for the first time in ALL my life i will NOT be passing out candy for Halloween or giving the grandkids holiday candy in their stockings this year. My personal protest.

[disneysteve]

In IL we just changed 9/1 from bag/bars of candy being taxed as the lower food rate (2.25%) to the higher non-food rate (10.25%). yougurt cover raisins are NOT food but Good n Plenty is because it "contains flour."

I believe NJ went to this same tax structure a few years ago, so a plain Hershey bar is candy but a Twix bar with the cookie center is food because of the flour. Makes no sense and I have no idea if there is any compliance with this law.