Drip Portfolio Report

<THE DRIP PORTFOLIO>
The Taxman Cometh
The long and short of it

by Vince Hanks ([email protected])

NORTHVILLE, MI (March 5, 1999) -- April 15 is drawing near, and soon Tax Man Max will be rapping rhythmically at your door. This may spell dread in the minds of many Drippers (the impending filing deadline, not the friendly animated man walking through your neighborhood singing), but fear not, my Foolish Friend, it's not as dismal as it seems at first glance.

When it comes to tax time, Drips do require a bit more arithmetic and tedious recordkeeping than other investments. Be sure to keep a record of all your purchases (including dividend reinvestments) and sales, as well as any year-end statements or reports the transfer agent sends to you. If you're missing any records, contact the transfer agent and ask if they can provide past statements or summaries.

The Long and Short of It. Distinguishing the difference between long and short term capital tax gains will save you a lot of greenbacks if some of your shares were held more than a year and a day. Sales for a short term gain are taxed at your ordinary income tax rate, while proceeds from a sale after one year max out at 20%, or 10% for those in the 15% tax bracket.

With Drips, determining the cost basis and holding period for every incremental purchase seems a daunting task. As with most everything, though, a little organization goes a long way. Unlike mutual funds, the cost basis for shares of stock cannot be averaged out; each purchase must carry its own basis and holding period, as determined by the FIFO (first in, first out) or specific share identification methods.

To make things simpler, however, the IRS will allow you to consolidate purchases when reporting, differentiating only between long- and short-term holdings. Let's look at an example, shall we?

You've been Dripping The Motley Fool, Inc. (Ticker: FOOL) for two years, and this past year you sold some shares in order to help buy that life-size Borg you've always dreamed of owning. How do you record the gains for this sale? First, let's break down Da Numba's:

(We'll assume quarterly purchases for this Drip in order to condense this somewhat)

1/1/97: Price of initial share purchased $25. Commission $9.95. Total basis: $34.95.
4/3/97: Purchased 3.333 shares at $30. Total basis: $100.
4/3/97: Dividend paid $0.88. Purchases 0.029 shares at $30. Total basis: $0.88.
7/3/97: Purchased 2.857 shares at $35. Total basis: $100.
7/3/97: Dividend paid $1.25. Purchases 0.031 shares at $40. Total basis: $1.25.
10/3/97: Purchased 2.5 shares at $40. Total basis: $100.
10/3/97: Dividend paid $1.94. Purchases 0.048 shares at $40. Total basis: $1.94.
1/3/98: Purchased 2.222 shares at $45. Total basis: $100.
1/3/98: Dividend paid: $2.08. Purchases 0.046 shares at $45. Total basis: $2.08.
4/3/98: Purchased 2 shares at $50. Total basis: $100.
4/3/98: Dividend paid: $2.34. Purchases 0.047 shares at $50. Total basis: $2.34.
7/3/98: Purchased 1.818 shares at $55. Total basis: $100.
7/3/98: Dividend paid: $2.51. Purchases 0.046 shares at $55. Total basis: $2.51.

8/6/98: Sold 16.19 shares at $60. Commission $9.95. Net proceeds: $961.45.

Wasn't that fun to read? What we do next is separate the long-term holdings from the short-term. Since you sold on August 6, 1998, anything held longer than one year and one day prior to that is a long-term holding. We can draw a line through the purchases before that date as such:

1/1/97: Price of initial share purchased $25. Commission $9.95. Total basis: $34.95.
4/3/97: Purchased 3.333 shares at $30. Total basis: $100.
4/3/97: Dividend paid $0.88. Purchases 0.029 shares at $30. Total basis: $0.88.
7/3/97: Purchased 2.857 shares at $35. Total basis: $100.
7/3/97: Dividend paid $1.25. Purchases 0.031 shares at $40. Total basis: $1.25.

---

10/3/97: Purchased 2.5 shares at $40. Total basis: $100.
10/3/97: Dividend paid $1.94. Purchases 0.048 shares at $40. Total basis: $1.94.
1/3/98: Purchased 2.222 shares at $45. Total basis: $100.
1/3/98: Dividend paid: $2.08. Purchases 0.046 shares at $45. Total basis: $2.08.
4/3/98: Purchased 2 shares at $50. Total basis: $100.
4/3/98: Dividend paid: $2.34. Purchases 0.047 shares at $50. Total basis: $2.34.
7/3/98: Purchased 1.818 shares at $55. Total basis: $100.
7/3/98: Dividend paid: $2.51. Purchases 0.046 shares at $55. Total basis: $2.51.

We total the shares purchased for each period and the corresponding cost bases, and then on Schedule D, we'd enter the following (AOL readers -- expand window to view table):

                Date     Date   Sales    Cost     Gain
Description: Acquired:   sold:  Price:   Basis:  or Loss:
7.23 FOOL      VAR-L    8/6/98  429.36   237.08   192.28
8.96 FOOL      VAR-S    8/6/98  532.09   408.87   123.22

When selling a block of shares acquired on different dates, use VAR-L for long-term various dates and VAR-S for short term various dates. We prorated the selling commission to $4.44 for long term (7.23/16.19 = .446 or 44.6%) and $5.51 for the short term holdings (8.96/16.19 = .553 or 55.3%). The initial buying commission was for long term only, as it correlates only with the initial share purchase.

There we have it; our long-term and short-term gains based on multiple purchases on several different dates. Nothing a good calculator and a few hours of time can't tackle, providing good records are kept.

Dividends and Divi-Don'ts. If you're dealing in stocks only, and not mutual funds, Dividends paid to you are not capital gains, but rather income taxed at your normal rate. Don't forget to report all dividend income on Schedule B, whether the proceeds were reinvested or not. A dividend paid is income, regardless of what you do with it.

If this all seems overwhelming at first, there is a simplified tax form, as suggested by Pulitzer Prize-winning author Stanton Delephane. It reads as follows:

How much money did you make last year? Mail it in.

That should satisfy the government. Before ending this topic tonight, I'd be remiss if I didn't mention two tremendous resources that I greatly benefited from when filing this year: The Motley Fool Investment Tax Guide and The Motley Fool Tax Haven area online. Every question I had (and even some that I didn't know I had) were answered by browsing through these publications. FoolMart is even offering Free Shipping on the Investment Tax Guide if you order now!

Touchstone Friday. Any Quicken users out there? On Monday, George provided time-saving tax tips for Foolish users of Quicken. Also of note is an ongoing tutorial on Quicken use put together by several Dripping Fools on the message boards. Check it out!

Tuesday was D2: Judgment Day! Brian let us know if our latest oil companies got the axe or lived to see the second round (D2). Next up on the auction block was Texaco and Mr. Graney gave it the usual once-over on Wednesday to see if it would join Exxon Mobil and BP Amoco in D2.

Are Campbell's Sales Soupy? Jeff explained on Thursday how we might have been wrong in purchasing Campbell's in the Drip port. Or were we? The short-term can be misleading sometimes. I'm reminded somewhat of a song by Counting Crows in which they sing: "And in between the moon and you the angels get a better view of the crumbling difference between wrong and right."

Er, I'm not sure how that applies to investing or even to Jeff's column, but it did come to mind while I was reading it. On that note... Have a great weekend, Fools!

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