3/25: Dates to Remember; Paying Taxes with Credits Cards; and Unrealized Gains Tax
Tax Snacks: Bite-size tax news and information on the fly
Many federal deadlines share this date, including the following:
1. Individual income tax returns or extensions are due
2. Partnership income tax returns or extensions are due
3. First quarter estimated tax payments are due (corporate and individual)
4. IRA contributions must be deposited, if contribution is applicable to the prior year
89.4% of tax accountants in the U.S. will take this day off. (This is an estimate, based on the voice in this editor’s head that generates accurate-sounding statistics.)
When filing your 1040, if you are inclined to pay your remaining tax bill via credit card, you can do so, but potentially at great cost. The reason it is costly relates to the “convenience charge,” which is a fee, transparent to most consumers, typically paid by the merchant to the card provider. Unlike most merchants, the IRS will not pay this charge; you will. For more information on this and alternative methods of making payments, read here.
A very astute client asked me recently whether unrealized gains were taxed. I told him no, they are not; gains have to be realized (by selling the underlying investment) for the gain to be taxed. As he pointed out the reason for his question, I realized that there is a very common scenario where from the investor’s perspective, it does seem like unrealized gains are taxed. That scenario involves investment in mutual funds.
My client’s point was that he made an investment years ago in a fund, and since then has not touched it - he did not put more money in, and he did not take any money out. Yet he paid tax on gain related to the fund, and that seemed very much like being taxed on unrealized gain. The reason this occurs is that the fund itself generated gains on its own investments, and each investor is required to report his or her share of those gains, as if earned directly. The gain is in fact realized (as opposed to unrealized) by the investor, and the fund reports that gain to the investor and to the IRS. It does not matter whether my client reduced his holdings to cash, it was sufficient to trigger income for him that the fund reduced some of its holdings to cash. If my client then sold his holdings in the mutual fund, more gain (a sort of second layer of gain) could result in more tax. The investor is not really taxed twice on the same income, though, because his or her share of the fund’s gains is added to the investor’s cost basis, thereby diminishing that second gain. This method of taxation instead merely accelerates some gain for the investor, who in the end is taxed exactly once on the change in value relative to his or her initial investment.
None of this is news, of course, to a grizzled tax accountant veteran like me, but the perspective provided by this client question may change my responses. Next time I am asked if unrealized gains are taxed, I think my answer will be “sort of.”
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