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Tax and Financial News for August 2013

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Tax Breaks Provide Savings for Investors

This is the last installment of our series on tax breaks for investors. We will look into three more provisions that might provide tax advantages and help you build wealth.

Capital-Gains Exclusion

Qualified small business stock can be 100 percent exempt from capital gains taxes if the right requirements are met. There are four major conditions that must be met in order to be considered a qualified small business stock; however, taxpayers should be aware that these rules can be detailed and tricky. As a result, consultation with a tax professional is recommended. Here are the basic rules:

  • The company has to be a C corporation and the shares must be acquired when they were originally issued.
  • The shares must be held for at least five years and one day.
  • The company must meet certain eligibility and active business requirements during the holding period.
  • The gross assets of the company must be $50 million or less.

Under current rules, shares of qualifying companies must have been acquired between Sept. 28, 2010 and Jan. 1, 2014. Additionally, the exemption is limited to the greater of $10 million or 10 times the basis in the stock.

Capital-Gains Rollover

If you do not qualify for the 100 percent exclusion discussed above, you might still qualify for a related tax break. Gains on qualified small business stock can be deferred if you meet two provisions. You must have held the shares for at least six months; and you must reinvest the proceeds from the sale in another qualifying small business.

Capital gains rollovers tend to be popular among investors in startup companies and other risky ventures because it allows them to retain more profits for reinvestment and smooth out future losses.

Tax-Exempt Income

The interest income from municipal bonds issued by state and local governments or their agencies is often exempt from taxes. This mean that despite municipal bonds typically offering lower yields than other bonds, you might actually keep more of your income – especially if you have a higher marginal tax rate.

In order to know if municipal bonds are right for you, you need to compare them to a similar taxable investment. For example, let’s assume a situation where you are in the 35 percent federal tax bracket, file a joint return and have $50,000 to invest. You have two investment options: a tax-exempt municipal bond yielding 4.5 percent, and a taxable corporate bond yielding 6 percent. Here is the after-tax income from each investment.

Tax-Exempt versus Taxable Bonds
4.5 percent Tax-Exempt Bond 6 percent Taxable Bond
Cash investment $50,000 $50,000
Interest income $2,250 $3,000
Federal income tax in the 35 percent marginal tax bracket $0 $1,050
Net return $2,250 $1,950
Yield on investment after taxes 4.5 percent 3.9 percent

As you can see from the table above, the tax-free municipal bond provides a better net yield despite having a lower coupon rate. The tax-exempt bond provides even more benefit if state and local income taxes factor into your particular situation.

There are a few issues with municipal bonds that you might want to consider. The first is that tax-free municipal bond income is included in the taxability calculation of your Social Security benefits. This can result in substantial amounts of otherwise untaxed Social Security income becoming taxable. The second is that if you are subject to the Alternative Minimum Tax, you might have to include municipal bond interest income in your income tax calculation.


We hope this series on tax breaks for investors was helpful and informative. If you think any of these examples apply to your situation, contact your tax professional so you can take advantage of some savings.