Telling Tips is a series of articles from local experts to help you save money, make better decisions and plan for a better future.
Client Question: I contributed $5,000 to my IRA last year, and through a hot tip, bought stock in a really great company. Recently, this company’s stock’s stock fell to $0, and ceased trading. Can I deduct this on my tax return?
Answer: If your contribution was to a Traditional deductible IRA, meaning that you took a tax deduction for your contribution, then no. This is because you cannot write off the same amount twice — as a tax deduction, now, and as a tax loss, later. If the investment had done well, you would pay taxes on the distribution later.
If your contribution was to a Traditional Non-deductible IRA, or to a Roth IRA, meaning that you did not take a tax deduction for your contribution, then yes. You have a tax loss if you receive less than your investment. However, the loss can only be taken if you close ALL of your Traditional (Non-deductible or Deductible) IRA accounts, if that is where your loss occurred; or if you close ALL of your Roth IRA accounts, if that is where your loss occurred. This means that if you have four Traditional IRA accounts, for example, then all four would have to be closed, even if only one has a loss.
The loss is taken on 1040 Schedule A, as a miscellaneous itemized deduction, and along with your other deductions in this area, subject to the two percent of AGI limitation.
Did you even wonder how the IRA deduction came about? I’m going to tell you anyway.
Did you ever hear of the Studebaker? It was a manufacturing company that started in 1852 in South Bend, Indiana. At that time, its main product was wagons for farmers, miners, and then the military. At the time of the westward migration (and wagon trains), half of the wagons used were Studebakers.
Studebaker was once the largest automobile maker in the world, but by the 1960s, the company was having financial and labor problems, and became defunct in 1967. One of the reasons it closed was because their pension plan was inadequately funded so that thousands of workers would receive only a part, if any, of the pension they were promised. This was true of other companies as well.
Step in, Congress. In 1974 the Employee Retirement Income Security Act, ERISA, was enacted. This act regulated not only pension plans, but also retirement and health care plans. It allowed those who were not covered by a qualified employment-based retirement plan to contribute to their own IRA. Since then, the IRA has been extended to all those to have earned income.
These pensions and other retirement plans are costing the US Treasury more than $500 billion a year, and you will probably see changes in the amounts you are able to contribute on a pre-tax basis.
Other areas that may be changed are: employer paid health insurance, mortgage interest deduction, lower tax rate for capital gains and dividends, earned income credit, and state and local tax deductions.
One last thought: Suppose an employer hires someone to work for $60,000 a year. During the person’s second year of employment, for whatever reason, the employer pays the employee a $1,000 bonus. During the person’s third year of employment, because of economic conditions, the employer does not pay a bonus, but the employee receives the $60,000. Did the employee have a pay cut? Now think: If the Bush tax cuts are repealed, is this a tax increase?
Have a great summer.
Joseph Reisman, of Joseph S. Reisman & Associates, has been serving tax prep and business accounting expertise from his Coney Island Avenue office for more than 25 years. Check out the firm’s website.