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Archive for Sunday, October 23, 2005

As year winds down, start thinking about tax issues

October 23, 2005

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If you work for a company that offers flexible spending accounts for dependent care and health care, watch the mail for a pack of forms. At most companies, fall is sign-up time for the coming year.

FSAs allow employees to set aside up to $5,000 a year for care of dependent children and adults. Your contribution is automatically deducted from your pay each week and put in a special account used to reimburse you for qualified expenses.

Most important: The contribution is subtracted from your taxable income, reducing your federal income tax.

FSAs do have a drawback - the "use it or lose it rule." Any money not used for an approved expense within the permitted period is forfeited to the plan.

¢ Year-end tax planning can be confusing. But people who do it well are awfully pleased with themselves the following April, when they find how much they've trimmed their tax bills.

One of the trickiest areas is using investment losses to reduce the taxes on investment gains, especially when it comes to a blend of short- and long-term investments sold during the year.

Short-term capital gains are those on investments sold after being owned for 12 months or less. They are taxed as income, at rates as high as 35 percent.

Long-term capital gains are for investments sold after being owned longer than 12 months. They are taxed at rates from 5 percent to 15 percent, depending on your income.

Year-end tax maneuvers involve selling losers so taxes on winners can be reduced.

But what if you have a combination of short- and long-term winners and losers? Here's how it works, according to tax information firm RIA:

Tally the short-term gains and losses to get a net short-term gain or loss. Then do the same with long-term gains and losses.

If you have a net short-term gain and a net long-term gain, the first is taxed at income-tax rates and the second at long-term capital gains rates.

If there's a net short-term loss and a net long-term gain that's larger, the loss is subtracted from the gain and the remainder is taxed as a long-term gain.

If there's a net short-term gain that's larger than the net long-term loss, the loss is subtracted from the gain and the remainder is taxed at income-tax rates.

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