I recently witnessed one of the most distressing tax return sessions I have experienced - an elderly woman on a very modest pension that is partially fueled by dividends from a stock portfolio, including a stake in the company shown above. While she normally has to pay no tax at all, this time she owed more than $6,000 - and not because of the changes in tax laws, either.
Her broker caused her pain. Brokers will often cause you pain, too, if you accept their. advice blindly. Their compensation is based on an entirely different metric from your personal interests. Let's investigate how it happens and how it can be avoided.
At its heart, the situation was simple: she had held the stock for decades and the value had appreciated enormously. That said, you only sell such as stock if 1) you need the cash or 2) you think the company's (or the market's) prospects are changing for the worst. Neither condition held up here.
Rockwell has been in merger and/or buyout talks for the better part of a year. This broker sold in the low $140s, but ROK is in the mid-$170s today. Recent acquisition offers have gone up to $225 - almost 60% higher than the sale price. No smart trader sells so early in the M&A cycle.
Brokers in such cases may recommend turning over stock like this just to generate commissions, in a practice called churning. The worst part was, the broker did not warn his client about the tax consequences. In this case, she went from paying zero taxes in one year to having an adjusted gross income (AGI) in excess of $90,000, most of which is capital gain! And a tax bill none of us would want, especially not in her circumstances.
Had the broker had a tax conversation with her first - the kind that any responsible financial profession will have, but many do not - they could have structured the transaction to avoid the hit, by making a tax deposit off the sales revenue before it was reinvested. Alternatively, the sale could have happened over two or more years to reduce the capital gain and associated AGI.
Even if he had that conversation, it was a bad transaction not in his client's interest. This happens a lot to folks who stop paying attention as soon as they hire a broker. The brokers count on that.
Don't be like that client: Question the broker about every single piece of advice, and always ask about the tax consequences. If he doesn't know, consult a tax professional - someone like me. My only interest is your best outcome. Count On It!