Taxation of capital gains is a "triple dip" trick

Is there a tax deduction for the commissions that brokers charge when you buy your stock? G.R. Indianapolis

The commission you pay when you buy stock isn’t deducted as an itemized deduction when you file your tax return. But that doesn’t mean you don’t get a tax benefit for paying a commission when you purchase some stock. The commission that you pay gets added to the rest of the cost of the stock and becomes part of the stock’s basis. The basis is the amount you use to compute your gain or loss when you sell the stock.

For example, if you bought 100 shares of Microsoft in 1987 at $53 per share (total cost, $5,300), and paid a commission of $100 on the purchase, your basis in the stock is $5,400. Today, after 13 years of stock splits, you own 7,200 shares and the stock is worth $97.75 per share. The total value of your Microsoft stock is $703,800. Your total basis hasn’t changed, just the basis in an individual share has changed. Your basis in 7,200 shares is $5,400, which translates to $0.75 per share.

For each share of stock you sell today, you will pay tax on your sales price of $97.75 less your basis of $0.75, or $97 per share. That commission you paid when you bought the stock is really going to come in handy now. Since you were able to add the commission to your original basis, you save approximately a penny per share in taxable income! Yep, it sure is a good thing you didn’t get to deduct that commission when you paid it…

You’ll be happy to know that when you sell your Microsoft stock, and compute the gain on your sale, you will be able to reduce the taxable gain by any commission you have to pay a broker to make the sale. I’m sure this will save you a lot of money on your taxes.

The whole issue of taxation of capital gains is noteworthy. You invest in a company that is profitable. When the company makes a profit, the company pays tax on the profit. The company also pays a dividend to its shareholders who pay another tax on the profit of the company. As the company continues to prosper, the value of its stock rises. You sell your stock and make a tidy profit. Taxed again. Three times the government has an opportunity to collect tax on the same profit! It’s a very neat trick.

I received a refund from state taxes and from federal taxes for last year’s return. I don’t have a 1099-G which the tax instructions talk about.  Am I to put these two amounts in the number 10 box on my 1040?  I.D., Indianapolis

No wonder you’re confused. Line 10 of the Form 1040 includes the description, “Taxable refunds, credits, or offsets of state or local income taxes.” The tax return refers you to page 21 of the instructions where the tax treatment of refunds is discussed. But the instructions for line 10 do not specify what type of refund is to be included on line 10.

There is no tax on a federal income tax refund. The type of tax refund you report on this line is a state tax refund. If you live in a place where you file a separate tax return for your city tax, that city refund can be included as income on line 10 as well.

The reason the refund is taxed is that last year you took a deduction on Schedule A for the amount of state or local tax you paid, and now it turns out you got that money back. Since you deducted something you didn’t actually pay, you have to put the money back into your income. That makes sense. But what if you didn’t take a deduction for your state or local tax last year? If you didn’t itemize your deductions, you don’t have to pay tax on the tax refund you received.

Every good IRS rule comes with at least one exception. There is an exception to the rule that there is no tax on a federal income tax refund. If you received a refund of federal taxes that includes a little interest in addition to the tax refund, that interest is taxable to you. You report that interest just like you would report interest on a bank account, on line 8 of your 1040 or 1040A, or line 2 of your 1040EZ.