Tax Trap in Your Brokerage Account

By Lee Bellinger / January 2, 2014

You Could Owe Capital Gains Taxes on a Security You Never Sold

  • Lots of new tax traps designed to rip you off and guilt you for saying NO.
  • IRS scams against the public grow into full-scale rip-offs – Here’s the latest!

Stocks normally allow you to enjoy tax deferral on any gains until you actually sell and realize those gains. But in some rare circumstances that could increasingly become more common, you may owe taxes on capital gains you never actually received.

This tax trap springs when a U.S. corporation “expatriates” – reorganizes itself under a foreign parent corporation. The trap was set by Congress in 2003 after a few corporations in recent years had moved overseas to take advantage of lower tax rates. Under a complicated set of new rules, investors became liable for capital gains taxes when a U.S. company they own shares in converts to a foreign company.

You can reduce your chances of getting hit with a surprise tax on capital gains you didn’t actually receive by holding foreign stocks and/or mutual funds or ETFs in a taxable account instead of individual U.S. stocks. Holding U.S. stocks within an IRA, 401(k), or other tax-sheltered account will shield you from incurring potential capital gains liabilities before you actually take money out.

For those U.S. stocks that you hold or are interested in purchasing, take a look at their Annual Reports and see if any get 25% or more of their revenue from a single foreign country (you can usually find this disclosed in “Segment and Geographic Information” within the Annual Report). A company that gets more than a quarter of its business from another country could potentially do a corporate inversion and remake itself outside the U.S. It’s still only a possibility, but now you can guard against it.