Some investors manage their portfolio themselves, while others hire an experienced mutual fund or hedge fund portfolio manager. In both cases, it’s important for the investor to understand how the fees should be treated for tax purposes.
Tax reporting for brokerage fees
When an investor purchases a stock, bond or other security and pays a broker to execute the transaction, they typically are charged a broker fee or commission. Those brokerage fees are added to the purchase price which increases the investor’s cost basis. When the investor decides to sell that security, they are also charged a commission which reduces the amount of proceeds they receive. The two fees on both the purchase and sale, effectively reduces the amount of taxable capital gains for the investor. How does this work in practice. If you purchase $1,000 worth of a stock and paid $30 in commissions, your cost basis would be $1,030. Once you sell the stock, when it’s worth $2,000 with a $60 commission charge, your net sale proceeds is $1,940. Therefore, your net taxable capital gain is $910 and not $1,000. The $90 in tax savings might not seem like much, but if you have several transactions a year, it can really start to translate into significant tax savings.
How are portfolio management fees treated?
If they are management fees (i.e. asset based), then you can classify those fees in the miscellaneous expense line item of your tax return. However, it is important to note that miscellaneous expenses can only be treated as an itemized deduction if they are in excess of 2% of your adjusted gross income (AGI). For instance, if your adjusted gross income for the year is $100,000, you could only claim the amount of miscellaneous expenses that exceed $2,000. Also, there are several items that get lumped into miscellaneous expenses which include portfolio management fees, unreimbursed employee expenses, tax preparation fees, educator expenses, losses from casualties or thefts, hobby expenses, and certain legal fees. Still, are these amounts plus your other itemized deductions greater than the standard deduction? You need to ask yourself that question to determine whether or not there is a worthwhile deduction here. Also, if you are subject to alternative minimum tax, you may have to back out these fees.
What about performance-based fees?
These fees, which are sometimes referred to as carried interest, are treated as capitals gains for the fund managers. That may change in the future as many lawmakers want those fees to be taxed at ordinary income rates which are higher than long-term capital gains taxes, but that’s a whole other story. Since these fees are capital gains to the fund manager, they are treated exactly the same as broker commissions to the investor. For instance, if the investor’s share of the capital gain was $100,000 and the fund manager charges a 20% performance based fee, the total capital gain for the investor would be $80,000 and not $100,000.
What if my investments are held in a retirement account?
The tax characteristics of the retirement account such as a 401K or Roth IRA, would dictate the current tax treatment.
More Questions? Ask your tax deduction questions or find an accountant online.
Related Articles
->Why You Need Both a 401(K) And a Roth IRA
->The Wealthy Should Prepare For The Expiring Gift Tax Exemption
->Many Investors Will Face a 3.8% Investment Income Tax in 2013
