The tax laws are fairly complex and people make mistakes, but there are some mistakes that investors should not make.
- Taking short-term gains when waiting will turn the gain into a long-term gain. Appreciated gains on assets held one year or longer are taxed at a lower rate than those held for less than a year.
- Foreign stock investments held in a tax-qualified account. Many foreign companies are required to withhold foreign taxes on dividends paid. U.S. investors can claim a tax credit on their tax returns, effectively recouping this lost dividend, but only if the foreign stocks are held in a taxable account.
- Failing to realize capital gains. If you have a gain in a stock and believe that stock is now overvalued, do not allow fear of taxes to sell and lock in a gain. That is the trap that many tech stock owners fell into in 1999, just before the tech bubble burst in 2000.
- Failing to take capital losses. If you have a loss in a stock, the loss can be used to offset a realized gain in another stock, thus reducing your tax liability. If you still like the stock you have a loss in, you can buy it back later as long as you observe the “wash sale rule.”
- Taking a direct distribution from a 401(k) or similar retirement plan. Distributions from retirement plans should be done via a custodian-to-custodian transfer or you can be subject to taxes as well as potential penalties if you are under 59 1/2.