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My wife and I have been retired for two years and are in the 15% tax bracket. Checking things to do for income tax year 2012, we almost forgot that this is the last year that the tax rate on qualified dividends and long term capital gains is 0% for those in the 10% and 15% tax brackets. In 2013, the long-term capital gains tax rate will increase to 10% for our tax bracket.

In our taxable accounts, we are almost all in cash except for stocks in one company that I have held since 1985. In 1980, I became an eligible participant in my company’s ESOP (Employee Stock Ownership Plan) in which company stock was purchased each year for credit to my account AT NO COST TO ME. Due to changes in the Federal tax regulations, company contributions to the ESOP were discontinued at the end of 1982. After I left my company in 1984, my company closed my ESOP account and distributed to me 59 shares, which I parked away for the the long term. Well, some 27 years later those 59 shares grew to over 3,000 shares via numerous stock splits and DRIP. Over that period, I have neither bought (out-of-pocket) nor sold any stocks in this holding.

Since we want to take advantage of the 0% long-term capital gains tax rate for our 15% tax bracket and the company stock is currently hovering at an all-time high of $52/share, we want to sell all 3,000 plus shares by year end.

However, I have several questions about determining the cost basis:

(a) Can I assume a zero cost basis since the ESOP provided the original 59 shares at no cost to me?

(b) Or, in calculating the cost basis, must I account for stock purchases from dividends paid in the DRIP? The company’s dividends are qualified dividends. If yes, do subsequent stock splits in the DRIP account affect the calculation of the cost basis?

Regards,
Ray
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However, I have several questions about determining the cost basis:

(a) Can I assume a zero cost basis since the ESOP provided the original 59 shares at no cost to me?


Was any of their value reported on your W-2?

The IRS will not question a zero cost basis.

(b) Or, in calculating the cost basis, must I account for stock purchases from dividends paid in the DRIP? The company’s dividends are qualified dividends. If yes, do subsequent stock splits in the DRIP account affect the calculation of the cost basis?

Reinvested dividends increase your cost basis. Including them has the potential to reduce your taxes. If the gross sale is within the 0% bracket for capital gains, there isn't going to be any actual tax savings.

Stock splits for those shares purchased with dividends change your cost basis. If your cost basis for the original shares is zero, splits would have no effect on their cost basis.
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(a) Can I assume a zero cost basis since the ESOP provided the original 59 shares at no cost to me?

(b) Or, in calculating the cost basis, must I account for stock purchases from dividends paid in the DRIP? The company’s dividends are qualified dividends. If yes, do subsequent stock splits in the DRIP account affect the calculation of the cost basis?


This is actually a lot easier than it appears on the surface since you're going to sell all your shares. You can show your date acquired as "various." Your basis is the total of:

1. Any amount relating to the purchases reported as wages on your W-2's; plus

2. Your reinvested dividends.

As was mentioned in the prior response, the IRS will not question a zero basis, but that artificially inflates your income. It also increases the amount of state income tax you'll pay (if your state has an income tax).

Phil
Rule Your Retirement Home Fool
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the company stock is currently hovering at an all-time high of $52/share, we want to sell all 3,000 plus shares by year end.

That $156k of gross sales price. And given you very low cost basis, that means you will not remain in the 15% tax bracket and some (perhaps much) of that gain will be taxed at 15%.

You get the benefit of the 0% rate on long term capital gains only to the extent that that gain would have been in the 10% or 15% bracket if it were ordinary income. When the gain puts you through the 15% bracket and into the 25% bracket for ordinary income, it will be taxed at 15%.

It might not be a bad idea to sell enough of the stock to use up your low tax brackets and still pay no tax on the gain. On the other hand, if you have not maxed out the taxability of your social security benefits, then you might be increasing your taxes by selling, even if you remain in the 15% bracket.

Your best bet is to do some proper number crunching before selling. Figure up your regular income and deductions, and do a preliminary tax return. Then start adding in some projected capital gain from the sale of this stock and see what happens to your tax.

If you have a tax pro do your taxes each year, give him/her a call and set up an appointment to do some planning. In general, we really like clients who think ahead and try to plan rather than just do things without asking.

--Peter
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Reinvested dividends increase your cost basis. Including them has the potential to reduce your taxes. If the gross sale is within the 0% bracket for capital gains, there isn't going to be any actual tax savings.

With 3000+ shares at a current price of >$50, the sale proceeds will exceed $150K. That's outside of the 25% tax bracket if you take the easy way out and assume $0 cost basis (ignoring other income and deductions/exemptions).

It will definitely be worth your while to determine the correct cost basis for your shares.

Ira
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TMFPMarti writes (in part):

This is actually a lot easier than it appears on the surface since you're going to sell all your shares. You can show your date acquired as "various." Your basis is the total of:

1. Any amount relating to the purchases reported as wages on your W-2's; plus

2. Your reinvested dividends.


I reply:

One tweak may be necessary here. If you are still purchasing shares through a DRIP, then the purchases within one year of your sale are short-term shares which must be accounted for separately from the remaining long-term shares.

If you end up deciding to sell only a portion of your holdings, be sure you understand the rules pertaining to specific identification, because those rules, properly applied, can save you money. --Bob
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