Phanton Cap Gains

Tue, Oct 15, 2024 3:05PM • 8:55

John, very good to see we have a spooky topic, phantom income, and it's scary tax implications. Few things sound scarier than phantom income. You would think that any kind of income would be good news, but this one and the taxes that come with it can take a lot of investors by surprise. So what is phantom income? So it's Halloween time. The Phantom capital gains ghouls and goblins are out here. And folks, you hear phantom income, and you think, what you receive something. Well, guess what? Phantom capital gains income, you didn't receive anything. So what am I talking about? First and foremost, this is for non qualified money. This is your individual, your joint or your trust brokerage account. This is not pertaining to IRAs, however, what we need to understand is that anytime you make a sale of an investment in one of these non qualified accounts, you trigger a tax gain, whether a long term or short term capital gain. A lot of people don't know about that. And where this really becomes an issue is when people love to use those diversified investments known as mutual funds. Folks, if you have mutual funds and non qualified you have to understand this. You have a money manager that is managing a basket of stocks or bonds or alternatives. When that money manager makes a sale inside that mutual fund that triggers a tax implication that is passed to you, the investor. So I've seen a lot of this, where this is honestly one of the biggest mistakes I see in my office. Erin, when people don't understand they've never heard of capital gains, or advisors are paying attention to taxes. I hear this. Listen, Mr. And Mrs. Client, you paid more taxes because we made you more money? Well, folks, you're making more money. That's great. But as we always say, it's not what you make, it's what you keep. There are much more efficient vehicles than mutual funds to help keep those gains in your pocket. So phantom capital gains are triggered on the sale, not on the distribution. You never got to enjoy the money, but you sure did pay the tax on it. So this bears repeating, John, you are paying taxes on money that you never actually received. Absolutely you you sold an investment, or your mutual fund manager sold an investment. You don't know. You're minding your own business. You're looking at your portfolio go up, and then all of a sudden, boom in January, you get a 1099, with this huge amount of capital gains. And you didn't get to enjoy that money. I was just going to ask, How do I know if I'm paying this tax? So it comes in my tax return? Yeah. So yeah, yeah. At that point in time, you're going to see a Schedule D, and it's going to have a long term capital gains and you also see it on the first page of your 1040 but more in detail on your schedule D, but if you do pay attention to those important tax documents, your custodian sends you the 1099 will show it. And folks, I mean, I I've had clients with a lot of money and non qualified accounts. I had former advisors, and they were just flabbergasted at the amount of capital gains. And you have to write that check. And Aaron, I don't know if you're like me, my clients sure are. They do not like writing that check to the IRS. So you know you have to be aware of what you're invested in when it comes to non qualified accounts. And I know you focus on strategic tax planning. So how do we avoid phantom income? Yeah, well, you know, every good Hollywood Halloween movie was The Exorcist, let's be the tax planning exorcist. First and foremost, there stop with the mutual funds and non qualified accounts. Plain and simple. You can use stocks again, if you sell a stock to get out of that risky position, you're going to trigger a gain. So Moreover, the preferred investment I like are ETFs, because they greatly reduce your exposure to phantom capital gains. That's a big one. You do have a couple other strategies, right? You can do some tax loss gain or harvesting that is to help control the cost basis, or what your capital gains are taxed off of. And you know, Aaron, when you're doing tax planning, you have to understand that the only good thing about these phantom capital gains, is it? It raises your basis back up, but you want to decide when to do that, not to have it randomly happen. Yeah, there's also a bonus, scary tax surprise you wanted to talk about, yeah? So you know, capital gains, it's kind of like one of your favorite games. It's like Jenga. I'm very good at Jenga. You are very good. Now here's the problem, Aaron, what if you pull out the wrong block in Jenga? You lose? Yeah, the whole board comes crashing down. That is very much a point when it comes to non qualified accounts, if you have the wrong investment, the wrong strategy, and you pull that that block out, you can have a catastrophic event on several other things, not only will you pay more in in ordinary your capital gains taxes, but it can and will affect the taxation of two tax portfolios in retirement, that is Social Security and Medicare. So again, imagine you're just going along, minding your own business, watching that portfolio grow, the capital gains trigger a Medicare tax increase, and now you're spending a couple extra $1,000 a year in something that could have been avoided. So pay attention to this. The other thing when it comes to tax management, Aaron is, you know, if you have an ETF or a stock position and you're in poor health, or you know you're older, and you know, perhaps you're doing some exit strategy planning and some estate planning, selling a long term holding is not beneficial to you, because you now reset the cost basis, and you may have the ability to take that low cost basis and transfer it to a step up in date, or A step up in basis, which means if you die in the near future, your beneficiaries only get the growth of the value from your date of death. That can be a huge tax game that no one also thinks about. So are there any other strategies to avoid phantom income, other than considering ETFs instead of mutual funds? Well, you know, it's just, you know, like we said, you have to look at very strategic, other very strategic strategies, like tax loss and tax gain harvesting. You have to understand those. And you really have to have the tax planning software to understand that. Hey, you know, yeah, we're doing this tax gain harvesting, but we're not paying attention to the other things, like like health or the effect it could have on your Medicare. So again, to consider, yeah, yeah, it's a game of Jane. Have to pull out the right blocks. You have to be very strategic. And you have to understand, most importantly, that if you make a sale, if you do anything, a defensive position in a down market, that you have to understand that there could be some tax liability that come along with that allocation shift. Yeah, it's a really great analogy. Good time to remind everybody, too, that we have so many great videos up on YouTube to make sure that they can absorb all this great information on their own time. So just a reminder to like and subscribe. But John, if somebody has more questions, how can they get a hold of you? Yeah, well, you can always visit our visit our website, www.gosecurus.com we have a library of information, their blogs, videos, podcasts. And while you're on the website, you can visit the contact us tab, where you can schedule a 20 minute complimentary phone call, where we'll answer any general questions you may have about this topic. Or you can schedule a six a minute, 60 minute complimentary vision and clarity consultation. Or if you like doing things the old fashioned way, give us a  call at the office, 858-758-9889, and they will get you on my schedule.