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Many people who buy mutual funds and other stocks often end up paying tax twice when they finally sell the security. This is because they do not keep track of their "average cost base" per share. This problem is very prevalent on investments when the dividends have been reinvested in the same security. Most mutual fund investors reinvest their dividends in more shares of the same fund. Many large corporations offer dividend reinvestment programmes that allow the shareholder to acquire more shares of the corporation directly without any brokerage charges. While reinvestment of dividends is usually an excellent idea, it does require some record keeping on your part to avoid double taxation. Many financial planning firms provide this tracking as part of their service. In my experience almost every case that I have looked at after a sale, has resulted in the reinvestment of dividends not being accounted for. For example, let's say you bought units or shares in XYZ mutual fund in 1990 for $ 10,000 when the shares were $5 each. So you got 2000 shares. At the end of the year, the fund will declare a dividend equal to the total of its realized capital gains, dividend and interest income etc. less the fund's expenses. Let's say this dividend worked out to 30 cents per share. On 2000 shares that is a $600 dividend or 120 more shares if the unit value hasn't changed since you bought into the fund. You will receive a T3 slip in March for that dividend whether you take cash or additional shares for it. If it is a mutual fund corporation you will receive a T5 slip for the dividend declared at its fiscal year end. The tax effect is the same. The point to understand here is that you will be paying taxes that year on that dividend whether you receive it or not. If you reinvest the dividend in more of the same shares, for tax purposes the "average cost per share" has now risen by 30 cents per share. Your total investment is now $10,600 (2120*5.00) from an income tax point of view because you will already have been taxed in the current year for the $600. Now lets assume they pay the same dividend on the same unit value in 1991, 1992, 1993 and then you sell your shares in XYZ mutual in 1994 and receive net proceeds of $14,000. Most people I have found would report a capital gain of $4,000 on their tax return and forget that they already paid tax on four annual dividends. The capital gain is actually $1,600 ($14,000 - $10,000 + 4 x $600), less than half of what is often reported. The good news is that if this has happened to you, you can apply to have an adjustment for at least the last three years of tax returns and sometimes further back than that. As you may sell a portion of your shares instead of the entire position, it is necessary to keep track of these matters on a price per share basis, rather than the total investment. By adding the dividend per share to the previous cost per share, you now have the new cost per share for future redemptions. This calculation is especially helpful if you are taking a regular monthly income from a mutual fund-often referred to as systematic withdrawal plans. As there are often twelve redemptions per year, a simple record is necessary to come up with the taxable portion for tax time. If you don not keep track of your cost per share you will be paying more tax than necessary. If you have other losses to offset your gains, you will be using up your losses needlessly. All of these are forms of double taxation, which result from not keeping track of reinvested dividends. If you want a form for keeping track of your cost base there is a free Form for tracking ACB, which you can download, form our web site at www.money-software.com Copyright 2004 www.money-software.com
Article Source: http://www.bharatbhasha.net Article Url: http://www.bharatbhasha.net/finance-and-business.php/23890 LD
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