The dramatic drop in stock holdings has advisers working closely to help investors determine whether to claim tax losses.
The dramatic drop in stock holdings has advisers working closely to help investors determine whether to claim tax losses.
In order to claim a tax loss, investors can sell the stock or prove it is worthless. But proving whether corporate stock has no value isn't as easy as it may at first seem, advisers said.
Tax rules for worthlessness differ from the general perception of worthlessness, said Vinu "Vinny" Satchit, a certified public accountant and senior manager at Grant Thornton LLP in Charlotte, N.C.
For tax purposes, worthlessness has to be evidenced by current balance sheet insolvency and a complete lack of future value, he said.
"This is different from situation to situation." Mr. Satchit said. "To be fair to the [Internal Revenue Service], it's hard to define every instance to say that a company can have no expectation of future value."
Timing is important, and the worthlessness deduction can only be claimed in the year the stock be-came worthless, not the year before or the year after, he said.
The simplest way to declare stock losses is to sell the stock before the end of the year, but that means investors have to pay commission fees to claim a loss on their taxes, Mr. Satchit said. Some investors prefer not to sell the stock and still claim the losses by declaring the stock worthless, he said.
"People in their mind have a conception of a loss, but you really don't get the loss until you sell it," Mr. Satchit said.
It's a complicated issue, and Michelle M. Musacchio, founder and president of Louisville, Ky.-based Fit Money CPA, said in some cases, she's telling clients to hold on to stocks rather than sell them.
For example, even though the fate of Wachovia Corp. of Charlotte, N.C., is not yet settled, if Wells Fargo & Co. of San Francisco continues to pursue its purchase of the bank as it intends to, it may make an offer to Wachovia stockholders.
At press time, the fate of Wachovia was still undecided.
"I believe the acquiring company will come out and give some guidance to shareholders," she said. "They don't have to, but I believe they'll give something per share."
Other advisers are suggesting that investors take their losses at present. In some cases, the easiest thing for investors to do is sell the stocks now, said Charles J. Farrell, a tax attorney and an investment adviser with Northstar Investment Advisors LLC in Denver, which manages about $300 million in assets.
"If you can sell them, you can recognize the loss," he said. "But if it's inside a retirement plan, you're stuck. This is very hard because of all of these land mines that have gone off in the market in the last year, a lot of people will be stuck with a lot of things."
Declaring a stock as worthless without selling it is complicated, and the Internal Revenue Code is murky about the rules, Mr. Satchit said.
The IRS has filed lawsuits over worthless-stock losses claimed by taxpayers and argued that investors had claimed a stock was worthless when the agency believed that the company still had value.
As advisers work with clients at the end of this year to provide guidance on how to handle this sticky situation, they need to be cautious, Mr. Satchit said.
Even if a company has filed for bankruptcy, that doesn't necessarily mean that an investor can claim its stock as worthless, he said.
In some cases, investors sell their stock to brokers for $1, but the challenge is when investors don't sell the stock but still want to claim losses next year, Mr. Satchit said.
"If Dec. 31 passes and they didn't sell it, it's too late to go back, and that's the biggest problem," he said.
Choosing a strategy depends on the company, said Morris Armstrong a certified financial planner who manages $10 million in assets with Armstrong Financial Strategies in Danbury, Conn.
He's trying to get clients to sell to get them to recognize the loss, but he's also suggesting that if a client believes a company such as Wachovia will turn around, he or she may want to sell the shares, wait 30 days and buy them back under the IRS wash sale rule.
The rule was originally imposed to crack down on taxpayers' trying to get a tax reduction from a wash sale, in which they simultaneously buy and sell a security through two different brokers, causing the illusion of activity, and recognize a tax loss without actually changing position.
"Even if you want to recognize the loss, there are ways you can put in the loss and still own the stock," Mr. Armstrong said, referring to the tax complexity of some transactions.
While taxes play an important role, said Lou Stansolovich, a financial adviser with Legend Financial Advisers Inc. in Pittsburgh, it's a tricky situation. He wants clients to make the decision based on their overall portfolio, not just on taxes. The firm manages $350 million in assets.
"The first rule is you don't let the tax tail wag the investment dog," he said.
E-mail Lisa Shidler at lshidler@investmentnews.com.
