Glossary: Capital Gain/Capital Loss

income-tax-491626_1280 (2)In the tax world, a capital gain or capital loss results from the sale of an asset.

To calculate the gain or loss, you need to know two things:

  1. Your basis in the asset
  2. How much you received when you sold the asset

Basis

Basis means your stake in the asset. For most assets, your basis will be what you originally paid for it, minus any depreciation deductions taken against the asset.

If the asset is an investment in a partnership or S-Corporation, your basis is what you originally paid for your ownership stake, adjusted by the yearly profit or loss of the business, any withdrawals you’ve taken or additional money you’ve paid in, and various other factors.

(Note: this is a very, very basic overview of basis.)

Gain or Loss

If you sold the asset for more than your basis, you have a capital gain. If you sold the asset for less than your basis, you have a capital loss.

The tax treatment of that gain or loss varies. Long-term gains result from the sale of assets you’ve held for more than one year. Special tax rates apply to long-term gains. Short-term capital gains are typically considered ordinary income, meaning no special tax rates apply.

This is a general discussion of gains and losses. It can get complicated if you’re selling business property and depreciation was claimed, some or all of the gain may be considered short-term, even though you’ve held the asset for more than one year. This is called depreciation recapture, and is a different topic for a different day.

Losses

Capital losses can be deducted on your personal tax return but are generally limited to a maximum deduction $3,000 per year.

Marriage in the Tax Code, Part 7: 1920s Court Battles

wedding-rings-150300_1280The IRS issued a ruling on community property laws in 1920, and then modified its stance several times throughout the 1920s.

The IRS originally said only spouses in Texas and Washington could apply community property laws, and then only on non-wage income (dividends, interest, etc.).

The U.S. Attorney General then jumped in and concluded that community property laws applied to all income in every community property state – except California. (For more information, see this research paper by Professor Pat Cain.)

A couple from California named Robbins challenged the Attorney General’s ruling. The couple had, in 1918, filed separate returns using community property law, even though Mrs. Robbins had no income herself.

The couple was victorious in Federal District Court in 1925. But the government appealed to the U.S. Supreme Court, and the Supreme Court ruled against the couple and in favor of the government in 1926.

The Supreme Court ruling was based on an interpretation of California community property law as giving the husband complete control over all community income. Therefore, the husband should report – and pay tax on – all community income, even income earned by the wife.

The Robbins ruling caused the Treasury Department to revisit its stance on community property rules. Now they proposed that community property rules do not apply in any community property state and that husbands should be taxed 100% on all income, even if the wife had her own separate earnings.

Taxpayers and elected officials in community property states protested. The Attorney General responded by holding public hearings, which ultimately ended in new guidance being issued — culminating with another Supreme Court ruling.

More on that in Part 8.

What to Do with a K-1 with a Fiscal Year End

K-1Question: I received a K-1 from a partnership I’m invested in. Their fiscal year-end is September 30th.

The K-1 for the year ended September 30, 2014 shows that it’s a 2013 K-1. I received the K-1 in 2015. What year do I report this K-1?

Answer: for taxpayers receiving a Form K-1, the information is reported based on the fiscal year-end. In this example, the information would be reported on the taxpayer’s 2014 tax return because the K-1 relates to the year ended September 30, 2014.

The fact that the form says it’s a 2013 form is relevant on the partnership side (the partnership’s tax return for the FYE 9/30/14 is considered a 2013 filing on the partnership side). But this isn’t relevant for the recipient.

Send a 1099-C to a Non-Paying Customer? Updated

invoice-153413_1280
Image courtesy of user OpenClips on Pixabay.com

More than 2 years ago, I wrote a post about whether or not it was okay for a business to issue a Form 1099-C to a customer or client who failed to pay an invoice.

I researched the issue heavily at the time, and turned up almost no information. Based on what little I could find, I concluded that it was probably okay to send a 1099-C to a deadbeat customer, but that I thought it was a bad idea.

We now know a little more about the IRS’s view on this subject, at least as it relates to tax professionals sending deadbeat clients a 1099-C. The IRS addressed the issue in an alert from the Office of Professional Responsibility dated February 5, 2015.

The alert is worth reading in its entirety, but here’s the bottom line from the IRS:

It is difficult to conceive of a situation in which a tax professional, principally engaged in providing tax services will be an “applicable entity” justifying the use of Form 1099-C to attribute income to an arguably scofflaw client for the nonpayment.

This alert from the IRS specifically addresses tax pros, but I think the concept could apply to all businesses in general. As I wrote in my original post:

Personally, I wouldn’t issue a 1099-C to a deadbeat client. I realize there may be some satisfaction in threatening a deadbeat and seeing them sweat. But I think it would cause more harm than good to go down the 1099-C route …. I would just fire them, move on with my life and replace the deadbeat with a better client.

Do I Have to Have Form 1095-A Before I Can File?

Image courtesy of user stevepb on pixabay.com
Image courtesy of user stevepb on pixabay.com

Scenario: Client received insurance through a health insurance exchange and received a credit to reduce his monthly premiums. The client has not received the Form 1095-A from the exchange yet. Form 1095-A reports the amount of credits received.

The client is antsy to get his return filed and get his refund, so he calls the insurance exchange to find out when the 1095-A will be sent. The person who answered the phone at the exchange told him: 1) they’re having problems getting the forms out (this is in Iowa) and 2) “you don’t need the form before you can file; there’s a box you can check on your return.”

Question: Is item #2 correct? If you received credits through the exchange, can you file without the Form 1095-A?

Analysis: I’m not an ACA specialist, but in this case the answer is clearly “no.”

You must have the Form 1095-A before you can file because you must perform a reconciliation of the credit you received versus the credit you were entitled to.

What about the “box you can check” that the person at the insurance exchange referenced? To answer, let’s review the two ways the ACA affects individuals:

  1. The individual mandate, which requires that we all carry health insurance
  2. Premium tax credits that people might receive if they purchased insurance through an exchange.

The “checkbox” refers to a box on Line 61 of Form 1040. If you were covered by health insurance for the entire year, you can check this box to show that you met the individual mandate.

There is no such checkbox for the premium tax credit reconciliation, which is accounted for on Line 69 of Form 1040.

There are two morals:

  1. Yes, you need the Form 1095-A if you got premiums through an insurance exchange
  2. You probably won’t get good advice from the people at the exchange that you might talk to on the phone