Junk Bond Loss Can Be Written Off Over Several Years
QUESTION: My husband and I have been victims of a failed junk bond issue. We invested $20,000 in these bonds and we have been notified that it is unlikely that we will be refunded any money. How may we deduct this loss on our income taxes next year? At the time of purchase, we were told there was no risk.--R.S.
ANSWER: So much for risk-free investments!
Your losses are fully deductible, although it may take you several years to take full advantage of the deduction. Here’s how it works: In any given tax year, capital losses may be used to offset the full extent of any capital gains you receive from other investments. So, if you have gains of $20,000 this year from other investments, the two cancel each other out. But if your losses exceed your gains, the unused portion can offset up to $3,000 a year of ordinary income. You may save the unused portion and deduct it in future years from either capital gains or ordinary income.
For example, if you have capital gains from investments this year of $10,000, you would be able to offset that gain completely and deduct an additional $3,000 from your other income. The remaining $7,000 in losses could be carried forward to the next tax year. On that tax return, you could use those losses to offset capital gains income of as much as $7,000. Or, if you have less than $7,000 in capital gains income, you could offset that income and deduct up to $3,000 against ordinary income. Any remainder could be carried forward until it is completely used.
Schedule D of the tax form is used to report capital gains and losses. Complete it when you file your tax return next year.
Out-of-State Pensions and the ‘Source Tax’
Q: I am about to retire from my state government job and relocate to another state. I just read that my state of residence charges a “source tax” on all payments it makes to its out-of-state retirees. What is this all about? Is it some secret tax that the taxpayers don’t know anything about? I can’t seem to get a straight answer.--L.T.
A: Actually, it’s quite simple and not as sinister as you might think. Thirty-eight states in the United States levy an income tax on pensions that are based on work performed in those states. (California is among them.) The income tax is levied regardless of where the retiree is living when he collects his pension. The “source tax” you refer to is actually state income tax withholding, just as you now probably have taken out of your paycheck.
However, retirees who pay out-of-state income taxes on their pensions are allowed to deduct those payments from the income taxes they would otherwise owe in their current state of residence. In these cases, you are--more or less--paying the state where you previously lived the income tax you would otherwise owe to your current state of residence.
But, lest you think you have heard the final word on this subject, be advised that there are several movements afoot to eliminate income taxes levied on pensions paid to out-of-state residents.
The banner of this cause is being carried by legislators from states such as Nevada that do not levy income taxes at all. These states, understandably, attract a sizable number of retirees who argue that their pensions should not be taxed by the states where they were earned. Responding to their constituents’ concerns, legislators from these retirement havens have proposed federal and several state bills to eliminate out-of-state taxes.
But you can expect strong opposition from the 38 states levying the taxes. Officials of these states argue that since most pension contributions are not taxed when they go in, they should be taxed when they are paid out. And they contend that the taxes are owed to the states in which the money was originally earned.
Stay tuned; this is not a fight that is going to end quickly.
Grandchildren Liable for Taxes on Accounts
Q: I have purchased certificates of deposit for each of my five grandchildren under the Uniform Gift to Minors Act. However, I have never told their parents of my actions. This year some of these accounts will earn more than $500 in interest. Who is required to report this income and pay the taxes, the parents or me? --M.S.
A: Under the Uniform Gift to Minors Act, taxes on the income generated by irrevocably held trust assets are the responsibility of the recipient, not the donor. Your grandchildren--not you or their parents--should declare the dividends on their tax returns and pay whatever tax is appropriate, provided the dividends or other unearned income total at least $500.
Although you may have been planning to surprise your grandchildren with these investments at some later date, you are probably well advised to disclose these accounts now. You can pay to have their returns prepared and can even pay the required taxes, but if your grandchildren are old enough to write, the law requires that they sign the returns. If you do not want to have the returns prepared for them and pay their taxes, your grandchildren--no doubt with their parents’ help--are responsible for these matters.
Clarifying Response on Social Security
Last week’s column on Social Security benefits for spouses contained erroneous information and dozens of readers have requested a clarification. So let us try to clear things up by repeating the question with a complete and corrected answer.
Q: All your recent discussion about Social Security benefits got me to thinking. Can my wife retire at age 62 on her own small Social Security and then, at age 65, switch over to the higher benefits as my spouse?--C. S. C.
A: It depends. What you propose is allowed only under certain circumstances.
If a woman is widowed after she starts drawing her own Social Security benefits, she is entitled to begin drawing widow’s benefits on her deceased husband’s account. If she is at least age 65, she would be entitled to his full benefits. If she is under age 65, the benefit payment rate would be lower and would be calculated according to how many months under age 65 she is. If a woman is widowed before she begins collecting Social Security, she can choose when she enrolls in the system which account she wants to draw on, her own or her deceased spouse’s.
The other circumstances under which your plan would work is when a husband had not yet filed for his Social Security benefits at the time his wife applies for benefits at age 62 on her own record.
If he hasn’t applied for benefits when she does, the only benefits to which she is entitled at that point are her own. However, when the husband applies for his benefits, the wife then becomes eligible to apply for spousal benefits. She may make the application at that point or wait until she turns 65. However, the wife’s spousal benefits will be somewhat reduced because she elected early receipt of her own benefits.
Your plan will not work if the husband has already applied for his benefits when his wife applies for hers. Under these circumstances, she will automatically receive the highest of all possible benefits to which she is entitled. If she’s 62 when she applies, she’s entitled to 80% of her own benefits or 37% of his benefits, whichever is higher. If she waits until age 65 to apply, she’s entitled to 100% of her own benefits or 50% of his, whichever is higher.
(Of course, you realize that all this assumes that the husband’s Social Security account is larger than his wife’s, which is probably true for the majority of today’s retirees. However, this same procedure applies equally to situations where the wife has a larger Social Security account than her husband.)
Carla Lazzareschi cannot answer mail individually but will respond in this column to financial questions of general interest. Please do not telephone. Write to Money Talk, Business Section, Los Angeles Times, Times Mirror Square, Los Angeles, Calif. 90053.
