As a kid, I didn’t have much to do with financial education. That’s in line with a wealth management survey that found that 37% of the people of my generation had no one to teach them about investing; among the baby boomers, the number rises to up to 38%.
That’s why I opened a minor account for each of my three children and encouraged them to invest through the platform. I wanted them to start learning about money – and yes, taxes – while they were young enough to make mistakes and ask questions.
My youngest has had a terrific return, leading him to a lawsuit, “I wish my eight year old I would buy more Sony.” My oldest – despite her best efforts – lost money when one of her investments went south. And my middle didn’t see a surge as they chose to keep everything as cash, but they brag, “I haven’t lost anything.”
That’s the nature of investing, isn’t it? You tend to expect your portfolio to appreciate in value, but it is sure to hit some bumps. Fortunately, most investors don’t lose real money when the markets fall. What they have is an unrealized loss or a loss on paper.
But wins and losses are not determined by the moment. To realize a profit or loss for tax and accounting purposes, you must do something with a capital asset. Typically, this means you will sell it or otherwise dispose of it.
Taxpayers who invest long-term – perhaps saving for a rainy day or retirement – usually don’t need to focus on those gains and losses because while the ups and downs can challenge your blood pressure, they don’t hit your wallet until you’re ready to pay off.
But what about those who buy and sell a little more regularly – like my children?
Capital gains and losses
Report your realized gains and losses at tax time. If your realized gains exceed realized losses, you have a taxable capital gain; the rate depends on whether those gains or losses are long-term or short-term.
If you hold most of the investments for a year or less and then sell or otherwise dispose of them, your capital gain will be short-term and will typically be taxed at your ordinary income tax rate.
If you hold assets for more than a year before getting rid of them, your capital gain will be long term. For 2021, the long-term capital gains rates for most capital assets are 0%, 15% or 20% depending on your taxable income; Special prices and limits may apply to works of art and collectibles, as well as real estate.
So far, this probably feels like a review of things that seem somehow familiar to you.
Child tax
But what about your kids? There are benefits to investing at a young age, but children who may not be filing a tax return may be unaware of the consequences of buying and selling stocks. And do you know who can find out first? Parents. This is due to the child tax.
The child tax only applies to income that is not earned. Unearned income typically includes capital gains such as dividends, capital gains, and interest. In contrast, income from work – i.e. income from wages, salaries, tips or self-employment – is not subject to child tax and is taxed as a child substitute.
But the fun money your child earns with their investments? It could add up on your tax bill. Here’s what it looks like: If your child is under 19 years old (or under 24 years old and a full-time student), your child’s unearned income below $ 1,100 will not be taxed. Your child’s next $ 1,100 will be taxed at the child’s tax rate, and any unearned income over $ 2,200 will be taxed at the parent’s tax rate.
What about children who buy and sell regularly thanks to online platforms? You can recycle the same $ 500 over and over as if playing the Vegas slot machines. Those wins may not feel like wins because of the losses – but they can add up.
Usually you can set off profits against losses. If your realized losses exceed your realized gains, you will have a capital loss. You can claim capital losses of up to $ 3,000 – $ 1,500 if you are married separately – each tax year. If your losses exceed these limits, you can conditionally carry the loss forward to future years.
Rules for the sale of laundry
There is one important rule that can limit your losses: laundry sales rules. For tax reasons, a wash sale occurs when you sell or trade securities at a loss and buy or acquire essentially identical stocks or securities within 30 days before or after the sale.
What is essentially the same? The IRS takes the “we know when we see” approach, taking into account facts and circumstances. Obviously, it is referring to the exact same stocks and affiliates. However, similar stocks or securities can also be meant. It doesn’t seem to contain any cryptocurrency.
In a wash sale, the loss is usually not recognized (there is an exception for professional traders) and instead you have to add the loss to the cost of the new stock – the holding period is also extended. The result of one laundry sale – or multiple laundry sales – can be reportable profits on your tax return even if you don’t have the money to do so.
To take steps
So what can you do now?
Limit the funds available. The easiest way to avoid paying child tax is to keep realized gains relatively small by limiting the money your child has at their disposal.
Have conversations. Talk to your children about tax ramifications and the appeal of long-term strategies like growth stocks.
Monitor accounts. Many of the new accounts for teenagers allow you to set up notifications to notify you of trades and transactions.
Consider a retirement account. Children can open IRAs with their own earned income, or you can top up the earned income up to the legal maximum and contribute it to a Roth IRA. Keep in mind that a Roth IRA can be used to pay for college as contributions can be deducted tax-free at any time, and income can be deducted without penalty if used to pay tuition fees.
Draw a few lines. Regardless of the type of investment, you should consider introducing some buy-sell rules with a 61-day limit to avoid selling problems later. Wash sales also apply to retirement accounts.
Investing can be fun and educational for teens. But don’t leave it up to your children to venture into this uncharted territory on their own. Playing an active role can help your teen develop healthy financial habits – and avoid a nasty tax time surprise.
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This is a weekly column by Kelly Phillips heir, the tax girl. Erb provides commentary on the latest tax news, tax law, and taxes
Politics. Every week, find Erb’s Bloomberg Tax column and follow her on Twitter at @taxgirl.