Wealthbuilder Series: Three Big Tax Traps To Avoid This Tax Season

Wealthramp March 26, 2022
Ara Oghoorian

 

This past year we’ve all experienced new challenges and turbulence due to all of the recent events taking place throughout the world and now we are facing the dreadful tax season. With all the new changes, many investors are left wondering how to properly handle these tax implications and avoid making costly mistakes this tax season. To help with these pressing issues, watch as Ara Oghoorian, CFA, CFP®, CPA and expert financial advisor sits down with our founder Pam Krueger to discuss the wash sale rule, how to correctly go back to your Roth IRA without making any mistakes and conclude with diving deeper to understanding the taxation of crypto investments.

 

 

Discussion Recording Transcript:

 

Pam Krueger:

Hi everybody. And welcome to this special installment of our Wealthramp Wealthbuilders series. Now, usually this is a live event and this time we're recording it for you. We do this once a month and we really want to take a deeper dive into topics that are current topics that you care about and most importantly, you've asked if you could meet our experts on Wealthramp so that's what we're doing today.

I'm Pam Krueger. I'm the founder of Wealthramp and co-host of the Friends Talk Money podcast on PBS Next Avenue. Now for anybody who doesn't know, Wealthramp is where you go when you're looking for the right financial advisor is your advisors who work only and directly for you. They're not sales reps who work at brokerage firms or insurance companies. So when you do want an advisor, you want to know that they are legally bound to act in your best interest. Wealthramp is your go-to resource for all things to educate you about how fee-only fiduciary financial advisors really work.

Today we really want to help you sail through this tax season. God knows we had enough going on in the world around us, and now it's tax season on top of it. To help you, especially as an investor from that point of view, we want to help you make the most savvy tax moves you can and avoid the biggest mistakes that investors sometimes make that are very expensive so we're going to focus on three things that are especially important this year. I'm going to tell you what they are really quickly and then introduce my guest. First of all, we're going to talk about something called the wash sale rule. Secondly, we're going to talk about going back to our Roth IRAs and how to do it right and what to do to make sure you don't make mistakes. Thirdly, because this is a hot topic you've been asking me for is taxation on crypto investments.

I've asked Ara Oghoorian, he's a CPA, CFA, he's way overqualified, and a CFP who is founder of his own investment advisory firm, ACAP Asset Management and he's going to guide us through. Ara is amongst the 240 advisors in the Wealthramp network. He's based in Los Angeles and has clients all over the country and 26 years of experience in addition to all those credentials. Ara, thanks so much for helping us get through the tax season. Let's tackle some of these important moves and take them one at a time. I'm so happy that you're doing this for us.

Ara Oghoorian:

Thank you, Pam. It's great to be here. Thank you so much for having me. It's wonderful to do this with you and interact with your viewers and your listeners, so I'm happy to talk about the subjects. We're still in the mid season and we come across these questions all the time.

Pam Krueger:

Yeah. That's why I think it's really important to go over, first of all, maybe give some context. We're going to into, first, the first bullet of three is explaining something called the wash fail rule. Now that's in the context of tax lost harvesting. Maybe we kind of start from the big picture of what is this and what are we washing and what do we have to watch out for?

Ara Oghoorian:

Okay. The wash sale rule, which we're beginning to see a lot more of on an annual basis, in fact, this year, we're seeing a lot more than we ever have, is essentially the IRS saying, "If you have a loss, you cannot deduct that loss if you buy the same security or an identical security either 30 days, within 30 days after or 30 days before."

I'll give you an example of what that means. Let's assume that you buy Google stock, I'm just going to use an arbitrary amount. You buy it for $100 and then it's lost some money so now you want to sell it, and you want to deduct that loss on your taxes and Google's gone from $100 down to $50. Theoretically, you should be able to deduct that $50 on your taxes because it's a realized loss. However, if you repurchase Google within 30 days at whatever amount it is, most likely it hasn't recouped that loss, you're not able to deduct that $50 loss because now you're subject to what's called a wash sale rule. Whereas before you're able to deduct that at $50 loss, but if you buy it within 30 days, you're not able to deduct that loss.

Pam Krueger:

I see. Investors who are looking to write off those gains, very valuable, really have to be aware of this to not do it. Now what about stocks that are very similar to Google? Are there instances where it's not just that particular company, but it's something that the IRS says, "Ah, I thought you sold this, but you bought X back within 30 days." Are there any pitfalls there we need to watch out for?

Ara Oghoorian:

This is one of the benefits of doing the similar transactions with an individual stock, because you can easily argue that there's really no other company that's very similar to Google. Now, Bing is another search engine, but it's owned by Microsoft. If you buy Microsoft, I think you can easily make the argument that it's not a similar or identical security. But if you do this with an index fund then it becomes very difficult. If you buy an S&P 500 index fund and then you sell it at a loss and you buy another S&P 500 index fund, then that's very identical. It's very similar. It's going to be very hard for you to argue that with the IRS. But if you sell Google at a loss and then you buy Microsoft, which is also a search engine or has a search engine, then you can, I think, make the claim that it's not identical.

Pam Krueger:

Yeah, that's a really important distinction because when we say, "Just make sure you don't buy the same security, same stock, the same fund.," what you're really saying is if it's a mirror image index fund or ETF, guess what? Even though it's a different promoter behind it or managed by or put out by, I should say, another company doesn't matter if it still has the same securities in it. Okay. We don't want to trigger any issues with any wash sale rules. Okay. Clear.

Now, in the sense of the bigger picture of tax loss harvesting, what else are you seeing right now? Anything else before we move on the next point with regard to this season or just overall advice on tax loss harvesting?

Ara Oghoorian:

What we're seeing is most people are not really taking advantage of tax loss harvesting. They're just kind of sitting on their losses, hoping for it to recoup because some of the major market indexes are down almost 20%. In those instances, investors should be really looking at tax loss harvesting, selling those investments at a loss, and then waiting at least 31 days before they repurchase them. But the wash sale rule, we're seeing people really get entangled with this on a day-to-day basis, especially people that are training on apps like Robinhood or other apps that are allowing these people to trade really rapidly on a day-to-day basis. They're really tangled with this wash sale rule.

Pam Krueger:

Right. By the way, I'm literally, that's not a fake background, I'm really at a park so you might hear kids and so forth in the background.

Ara, let's move on to point number two.

That's a good call that everybody who's an investor needs to really watch out for, be mindful of, thank you. Moving on the backdoor Roth IRA, it's a conversion where you can pay taxes up front on converted pre-taxed funds and everything after that is tax free. Let's take the mystery out of this and just explain who does this, when do they do it? How do they do it? Why do they do it?

Ara Oghoorian:

Okay. The Roth IRA has income limitations for eligibility. If you exceed these income limitations, you're not able to contribute to a Roth IRA. Now, that's a keyword is contribute. However, there is a rule that says regardless of how much money you make, you can put money into a regular IRA and not deduct it. It's a non-deductible IRA. You can make millions of dollars a year and put money into a non-deductible IRA. There's also another rule that says you can always take an IRA and you can convert it to a Roth IRA. Now, if you haven't deducted the money, then there's no tax implications because it's post-tax money. What the backdoor Roth IRA allows high income earners to do is to put money into a regular IRA, they don't deduct it, and then immediately convert it to a Roth RIA. By doing this, it provides them with that backdoor Roth IRA access.

Now, keep in mind we're not advising clients to do backdoor Roth IRAs in 2022, because the Build Back Better America Act, I may be butchering that law, but there's a high probability that the backdoor Roth IRA may be going away so we don't want to expose clients to that this year and then have it have them reverse it later on during the year.

Pam Krueger:

Wow. When are you going to have more updates on forecasting whether or not that actually happens?

Ara Oghoorian:

I think everything's going to really depend on the midterm elections. After November, we'll have better clarity on what happens with Congress and then depending on the outcome of those elections, we'll know what sort of things are back on the chopping block with the Build Back America Act. If the back to Roth IRA happens to be one of them, then we'll know whether or not to do it for clients.

Pam Krueger:

Okay. Let's assume that it doesn't go away. Okay.

Ara Oghoorian:

Yeah, everyone, right?

Pam Krueger:

Yeah. Explain what a mega backdoor Roth IRA is because we hear that term a lot as well for investors.

Ara Oghoorian:

Yeah. This is a rarely used instrument and it's kind of beyond your control. Your employer has to have this available for you to be able to do it. Essentially, your employer has a 401k account, you have a 401k through your employer and your employer says, "We'll allow you to make post tax contributions into this 401k account, up to the allowable maximum limit," which is about $58,000 right now. You can put the regular contribution to your 401k and then beyond that, you can make post tax contributions, which is also known as a mega backdoor Roth IRA or Roth 401k. But your employer's 401k has to allow these post-tax contributions to be able for you to be able to do this and not everyone can do it.

Pam Krueger:

Now, if you make a mistake, how do you fix that? In terms of like the backdoor Roth IRA making sure, because it's so many different ways you can screw that up. What do you recommend if someone comes to you, they're not yet your client, and they say, "Heading into tax season and here's what I did," and you see that they went about it the wrong way. How do you fix the remedy?

Ara Oghoorian:

Well, it's interesting you ask that question because we actually have a client right now that we're working with, who's been contributing to a Roth IRA before they started working with us and they were not eligible to contribute, their income was significantly higher. Now we've got several years of Roth IRA contributions, not even the backdoor Roth IRA, they were contributing to the Roth IRA. Now we have several years of contributions into a Roth IRA that has growth and has basis and we've got to really untangle that and try to figure out how much of it, well, we have to take all of it out, but now we have to calculate how much is taxable, how much there's a penalty, and it's going to require us contacting the IRS and really saying, "Sorry, our client made a mistake. Can we see if we can get some penalties abated or interest abated on this?"

Pam Krueger:

Yeah. Wow. Yeah. Both of those, both the wash sale rule and the backdoor Roth IRA, you can always try to fix the issues and there's always a remedy for doing that but the point of bringing these up right now is to be careful and not do them in the first place. Are the bottom line on backdoor Roth IRAs, because we get so many questions about this if you're just saying not right now. Just not going to do it yet.

Ara Oghoorian:

Yeah. Yeah. We're just holding off. In fact, actually last year when we had a hint that the Build Back America Act was potentially going to pass, in December we sent out an email to all of our clients and said, "Hey, listen, there's this possibility of this passing in 2022, let's get your IRA contributions and conversions done before the end of the year so that way we can bank it in the event that it does pass in 2022 and we won't have that opportunity to do it by April of this year."

Pam Krueger:

Okay. I think that's very important advice because so many people that I talk to are do it yourself investors, and they've been doing a great job of managing their own portfolios for years, but these are the tripping points and I think that it is really important to know that experts like yourself are saying, "Let's be cautious. Let's not dive into that right now." Hopefully it will be a strategy that will be preserved going forward.

Ara Oghoorian:

Certainly is popular. The objective here is not to create scare taxes for people. There's obviously, as you said, a lot of people that are managing their own wealth and it's completely fine, but the types of clients that come to people on Wealthramp or to us are people that just don't have the time or the interest or the energy to do it. Sometimes it gets overwhelming to do something really simple that you think is going to take you five minutes and then two hours later, you're still working on it. Our clients are like, "We'd rather just hire a professional that's going to know and oversee this on a day to day basis. If I were to do it on my own, I could do it, but I'd rather just focus on my career and my other objectives that are more important to me."

Pam Krueger:

I know Ara, I always say it's there's layers. There's layers of financial planning that are foundational and then there's layers of investment strategy that are on top of that, and then on top of that is tax focus and strategy. By the time you're really approaching retirement or even in your fifties, even if you've been a do it yourself investor doing a great job, we have a lot of people who come to me on a daily basis and say, "You know what? I just want to confer. I really want to collaborate with someone and get good guidance."

I always think of this as kind of minding the garden, if you will and when you have a mature garden that needs watering, feeding, deadheading, fertilization, sunlight, not too much of this, not too much that, and you put it all together on those layers and you say, "Holy cow. Do I really feel comfortable doing this completely myself?" This is the time when so many people, I have this discussion with, so many people who are kind of grappling with the idea of, "Should I go to a professional? Should I go to a CPA?"

I say, "Go to a CPA and you're going to get CPA talk. You're going to get tax tax tax, but you're not going to get the whole picture."

I think that this is the reason I wanted to focus on these issues today because this ties together the tax focus but on top of the investment strategy, which lies on top of the foundational financial planning.

The last point that I think that's really a hot topic, as we know, and I'm not saying that everyone who's about to retire has to run out and buy Bitcoin or Ethereum, I guess I did a little bit. Maybe this is for me, but people want to know, what do we need to know this tax season, right now, about crypto and taxes? Taxation of crypto assets.

Ara Oghoorian:

I wrote an article about this and it's very in depth as far as like the taxation of it, but I would say what you ought to know is if you're trading in your coin base account or Robinhood, which tends to be the most popular one, the average holding period for Ethereum and Bitcoin, which are the most as popular cryptocurrencies out there, there's a lot of other ones out there too, is about 80 to 90 days, which means that the majority of people are going in and out of these cryptos. If you're doing that, there are tax implications. The IRS considers virtual currency or cryptocurrency to be a capital asset so if you buy it and then you sell it or you exchange it or you pay someone with it, or you gift someone with it, there are tax implications for this. There's a lot of nuances to the taxation of crypto. Just be really, really careful when you're buying and trading these things.

Pam Krueger:

Boy, there's a lot to know there. Does that same advice go for NFTs?

Ara Oghoorian:

Yes, the same advice does go for NFTs, which are non fungible tokens, so it does go for that as well. The people who buy NFTs don't tend to trade them the same way that cryptocurrencies trade them. NFT holders tend to buy them and kind of keep them as a part of a portfolio. That's not to say that most people don't trade them, but the majority of people tend to hold them as part of a portfolio. Crypto traders tend to dart in and out of these things on a regular basis.

Pam Krueger:

Right. Right. I guess I put myself in the camp of an old fashioned, more conservative, buy and hold. Crypto assets. I'm not trading, but plenty of people are and plenty of people are going to get caught without really realizing and recognizing gains. Now. What about mining? For those people who are actually earning Bitcoin by not buying it, but mining it. How do the taxes work for that?

Ara Oghoorian:

Yeah. Before I answer that question on mining, which I will, I promise Pam, I just want to circle back to the wash sale rule because it does apply to crypto. Remember we were talking about the wash sale rule was you have to wait 30 days or 31 days before you can buy the security back. That rule currently does not apply to cryptos. People who are trading in cryptos are not subject to the watch sale rule.

Now, my suspicion is that's going to change really, really quickly, but for the time being that does not apply. Now, Pam to answer your question, about yeah, which is very surprising given how they're being treated. I should also note that the IRS has a laser focus on virtual currency and cryptocurrencies. In fact, they're so focused on it that on the front page of your 1040, right below your name, there's a question, "Did you transact, buy, trade, do anything in virtual currency during the year?" and it's a yes or no question. Most people kind of don't think about that question like they think about that presidential fund, yes or no, they don't give it much thought, but the IRS is really zeroing in on this.

Okay. Now, to answer your question, I promise I was not trying to avoid it.

Pam Krueger:

Heck, no. No, that's so important to know that. Thank you.

Ara Oghoorian:

Yeah. Now what happens if you mine currencies? If you mind crypto it and you receive it, that is ordinary income so it's as if you just receive wages, which is essentially what it is. You receive income from this mining.

Pam Krueger:

Yeah, you've earned it. Right?

Ara Oghoorian:

You earned it so now you have to pay income tax on it. Keep that in mind when you're mining these currencies.

Pam Krueger:

Yep. Okay, that's really important, but who knew that for the moment, and I guarantee you, and you probably feel the same, that'll be like one second in time that there's no wash sale rule applying to crypto. That's pretty interesting.

Just to sum things up, these again, are the three things to be aware of as an investor, as you're heading into tax season, things to be aware of. If you do mess up, there are always ways to fix it. Ara can fix it for you, I'm kidding. Call Ara.

Ara Oghoorian:

It takes a little time, but yeah, we'll try to unravel and fix it.

Pam Krueger:

If you're looking for guidance on anything, with your financial planning, your investment strategy and taxes, and investing, just head straight to wealthramp.com. This is where you're going to find Ara amongst our other highly qualified fee-only, fiduciary advisors and specialists. If you have any questions for me, you can ask me directly at askpam@wealthramp.com. I do answer every question, and then we turn it into a Wealth Builder video just like this one.

Ara, I just want to say thanks so much for joining us today. This was great information. Thank you.

Ara Oghoorian:

Thank you, Pam. One thing, if you're going to do the tax loss harvesting, which we talked about earlier on in the webinar, please, please, please make sure to educate yourself on FIFO, LIFO, weighted average and specific identification. If you're not familiar with those terms, do not trade anything until you educate yourself on those, because they're going to have a huge tax benefit or a disadvantage for you when you're doing those trades.

Pam Krueger:

Remember accounting 101, LIFO and FIFO. If you're not feeling like you you can put your accountant's hat on, your CPA hats on, yeah. That's super, super important.

Ara Oghoorian:

Oh, yeah. For a security it definitely, definitely applies so make sure you educate yourself on those terminologies.

Pam Krueger:

Yeah. Just one more thing to know.

Ara Oghoorian:

Yeah.

Pam Krueger:

All right. No, thanks a lot for mentioning that. I really appreciate that. Ara, I look forward to seeing you again and talking to you again soon. Thanks, everybody, for being able to take the time to do this and watch this today. Thanks.

Ara Oghoorian:

Thank you, Pam.

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