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updated 2/3/2004 5:38:33 PM ET 2004-02-03T22:38:33

The new tax breaks are great but made tax prep even trickier. Complex holding periods. Margin-account traps. AMT woes. What has Congress wrought?

It may seem perverse to look a gift horse in the smacker. After all, last May's federal tax cut, which sliced the top rates on both long-term capital gains and most dividends to 15%, helped an awful lot of Americans: two-thirds of folks with incomes of $100,000 to $200,000 receive dividends; 36% of people in the same bracket reported long-term capital gains in 2000. The problem is that Uncle Sam has made it tougher to account for the new goodies on your tax returns.

Your troubles will start when your broker mails you the 1099 tax statement, laying out your cap gains and dividend income. Schedule D, where you account for gains on your tax filing, has ballooned to 53 lines from 40 in 2002. That's because for 2003 there are seven different long-term cap gains rates, up from five in 2002.

It's also harder to pull off an essential tax planning maneuver--calculating how much capital loss you can carry over to next year, after you have deducted the maximum $3,000 this tax season. Because its forms are putting on weight faster than a male contestant on Average Joe, the Internal Revenue Service has ditched a helpful worksheet to figure out loss carryover that was in the Schedule D instructions. You can get a worksheet by asking for IRS publication 550, Investment Income and Expenses, but as of late January it hadn't been issued. The answer is to buy tax prep software like TurboTax and TaxCut that still calculates carryover.

Dividends are just as confusing. While the 15% rate applies to most corporate payouts, that's not the case for most real estate investment trust dividends or for bond fund dividends, which are really interest and are taxed at ordinary income rates of up to 35%.

To help you through the welter of changes, here are some pointers.

Don't rush to file. There's a good chance the first tax statement you get from your broker this year won't be the last--you might get an amended statement in another month. So, unless you're owed a huge refund, save yourself the trouble of amended returns; wait until at least the end of February to file.

The Securities Industry Association points out that back in 1997, when the capital gains tax rate was also cut, brokers sent out corrections on 17% of statements, compared with 5% to 8% in a normal year. "My fear is it will be worse than 1997," says SIA Vice President and Director of Tax Policy Patricia McClanahan. Of particular concern are foreign dividends--some qualify for the 15% rate and some don't, yet the IRS didn't issue the rules until late, Nov. 26.

Watch that holding period. You still need to hold a stock a year to qualify for the 15% cap gains rate (any less is taxed more heavily at ordinary income rates). Holding periods now affect dividends, too, and, alas, they're even more complex. To qualify for the 15% rate, you must hold a stock or fund for 61 days of a 120-day period. That period begins 60 days before the day a stock trades without its dividend, and ends 59 days after. If you don't hold a mutual fund long enough, the "qualified" dividend it reports won't actually get you the 15% rate on your personal tax return. At least one investment company is helping. Vanguard plans to send a second "personal qualified dividend income" statement at the end of February to any customers who might have holding period problems.

One trap: if your stock is hedged by a put or by a collar (where you buy a put to protect your downside and sell a call, which limits your upside). Every day you're hedged in such ways doesn't count toward the 61-day holding period, says Robert Gordon, president of Twenty-First Securities. If you've held a stock for years and now want to hedge, well, tough. It must qualify anew for the 15% rate on every dividend.

The funny thing about all this is that the IRS probably can't tell how long you've held or if your position is hedged--not unless it audits you. Your broker has to report only if you received a potentially qualified dividend, not whether you personally qualified.

Another trap: if you buy a stock or fund the day before it goes ex-dividend. The way rules work, you won't qualify for the 15% rate. Congressional tax writers say they intend to fix this, but haven't done so yet. That's another reason to delay filing.

Review your margin account. If you borrow in a margin account, there's a risk--not a big one, but a risk--that some of your dividends won't qualify for the 15% rate. It works like this: The brokerage firm is permitted to borrow stock from your account worth up to 140% of your outstanding loan balance and lend it to short sellers. If your stock is sold short when a dividend is paid, you get a "payment in lieu of dividends," which is taxed at ordinary income rates of up to 35% and reported on a 1099-Misc.

Don't panic. Because most brokers didn't have systems in place to track borrowing from individual customers, Congress and the IRS gave them a short-term pass. For 2003 most brokers will probably report these payments in lieu of dividends as qualified dividends, and you can treat them as eligible for the 15% rate. For 2004, however, brokers must track and report the higher taxed payments in lieu of dividends to both you and to the IRS. Broker Charles Schwab & Co., for one, plans to compensate customers whose stock is borrowed for the higher tax. Still unclear is how many other brokers will follow suit.

Meanwhile, the IRS has helped a bit; it is allowing brokers to count shares they lend to shorts as coming first from tax-exempt customers. That should reduce the borrowing they do from taxable accounts. And most stocks paying high dividends don't have high short interest anyway.

But stay on the safe side. The table shows stocks with above-average yield and noticeable short interest--the sort you don't want to hold in a margined account.

Consider the alternative minimum tax. The more long-term capital gains and qualified dividend income you have, the more likely you are to be thrown into the AMT. While the AMT theoretically taxes gains and dividends at just 15%, you could end up paying 22%. This hidden rate increase hits couples whose AMT income is between $150,000 and $382,000 a year.

The AMT can snag dividend and cap gains beneficiaries in other ways. It is a particular danger if you live in a high-tax area or earn $200,000 to $500,000; 55% of families in this income group will pay AMT for 2003, the Tax Policy Center estimates.

Some gifts from the government have unintended consequences. So before you rearrange your holdings to capture the 15% rate--say, by moving stocks to taxable accounts and bonds to tax-deferred ones--sit down with a tax pro or the right software.

© 2012 Forbes.com

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