Tax Strategies & Concepts
Interested in learning more about U.S. tax strategies and related concepts as they relate to U.S. income taxes? Our publication below covers this in form of short write-ups.
Taxation of appreciated inherited assets
A U.S. citizen (or a green card holder) purchased shares in S&P500 exchange fund for $30 K. Over the next 30 years, the fair market value of stock increased to approximately $880 K. The stock was passed upon individual’s death as inheritance to his descendant. The descendant sold the stock at its FMV of $880 K. Neither the deceased individual, nor estate or the decedent paid any U.S. federal income tax associated with the growth in stock value from $30 K to $880 K. No state income tax would apply in most but not all states. The same tax treatment applies in relation to inheritance and sale of most other appreciated properties, including real estate.
Taxation of annuity interest
U.S. citizen (or a green card holder) purchased an annuity. As part of the arrangement, the individual made a fixed upfront payment in exchange for a series of future payments. Specifically, individual paid $100 K dollars in exchange for monthly payments of $2 K, starting with individual’s reaching 65 years and until her death. Future payments would include interest and repayment of the principal, being the initial upfront payment. Let’s assume that individual is expected to live until 80 years. In this case, the total payout is expected to be $360 K, interest-$260 K, i.e., $360 K – $100 K. Interest is accrued to an individual account on a quarterly basis. The interest accrued is not subject to U.S. federal income tax until the individual withdraws it from the annuity account. The accrued interest kept at the annuity account is not subject to state income tax either. This tax treatment is different from taxation of interest earned on a bank saving account.
Taxation of death benefits of a life insurance policy
U.S. citizen (or a green card holder) purchases a life insurance. According to the terms of the policy, the individual is obligated to make premium payments at regular intervals until the occurrence of the insurable event, i.e., death. Insurance payment, i.e., proceeds from the insurance policy includes two components: 1) “pure insurance” against death and 2) saving element represented by the interest or investment income earned on the policy.
Component 1) represents a gamble on the timing of death of the insured. If the insured dies earlier, the policy holder generates mortality gain, if the insured lives longer than per mortality tables, he or she incurred a mortality loss. Any amount paid by the insurance policy because of the death of the insured is not subject to federal income tax. In other words, no federal income tax is assessed in relation to saving or gambling income of the insurance policy. No state income taxes apply either. Estate income tax may be assessed in certain instances.
Tax-loss harvesting
In the U.S., income taxes generally apply to a) interest from bonds, corporate debt and bank deposits; b) gain resulting from the sale of investments; c) dividends. Qualified dividends and long-term capital gains are taxed at a lower rate- 15% for most taxpayers. If you receive a cash dividend from a corporation or a fund and invest it right back, you still owe the IRS.
The strategy of ‘tax-loss harvesting’ involves selling loss-generating securities to offset taxable gains in a stock portfolio. Proceeds from the sale are generally reinvested in the stock market. Consider the following example:
$100,000 worth of stock was sold in 12/24 with a loss of $1,000. The losses fully offset taxable gains from other transactions. This offset generated tax benefits of $150 (15% of the $1,000 long-term capital loss). With the S&P 500 averaging an annual return of 10% over the past 20 years, $150 today could grow to approximately $2,617 in 30 years.
Securities sales must be properly timed to avoid triggering wash sale tax rules. A wash sale occurs when you sell a security at a loss and repurchase the same or substantially identical security within 30 days before or after the sale. Losses arising from wash sales are not immediately deductible. Additionally, tax ‘netting rules’ apply to short-term and long-term capital gains/losses, ordinary income, and carryforwards.
When tax-loss harvesting is applied to the S&P 500 or similar index funds, taxpayers often choose to own individual stocks in the index rather than the fund itself. This way, underperforming stock can be disposed of while other stock is held intact.
Generating tax losses in retirement accounts, such as traditional IRAs and 401(k)s, will not help since gains and losses in those accounts are generally not taxable until distribution.
FinAcco Contacts:
NICK LARCHENKO, Managing Partner
646.713.4764 / nick.larchenko@finacco.org
POLINA LEUDANSKAYA, Accounting Advisory Director
877.734.6222 / polina.leuda@finacco.org
MARINA SHMATIKOVA, Tax Director
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Important Note: FinAcco is not responsible for, and no person should rely upon, any information presented in this publication. This and other publications are prepared for general purposes only and do not constitute tax advice. FinAcco does not assume any responsibility for timely updates of its website overall or any information provided in this publication, specifically.
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