Participation in Dividend Reinvestment Program Demands Good Record Keeping

Q I have participated in a dividend reinvestment program since 1982 and expect to sell all the shares I hold in this company before Dec. 31. During the last seven years, I have paid income taxes on the dividends I received, even though they were reinvested in additional stock. How do I determine my tax obligation on the gain I receive from the sale? --C.L.

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A If your records are complete and up to date, you should have no problem determining your tax bill. The price you paid for the stock you purchased with your reinvested dividends becomes your tax basis in these shares. To calculate your taxable gain, simply subtract the basis from your selling price.

For example, let’s say you had reinvested $100 and had purchased four shares. Because you would have paid income tax on the $100 during the year in which the dividend was earned, each of the shares you purchased would carry a taxable basis of $25. If you sell those shares for $50 each, your taxable gain is $25 per share, or a total of $100.

Your calculations to determine gains on stock purchased over seven years will be more complicated than the above example, but the process will be eased considerably because you intend to sell all of your shares at once.

If you were selling only a part of your holdings, our tax experts say, you would have to specifically designate the shares you intended to sell, identifying them by their purchase date and price.

Most dividend reinvestment programs send their investors quarterly reports detailing the cash value of their dividends and the number of shares--with the price the investors paid for them--credited to their accounts.

If you have saved these reports over the years, you should know exactly the tax basis of every share you are selling. If you haven’t saved them, you can still retrieve the information you need. The investor relations department of the company should be able to help you navigate through your account and provide you with new copies of your purchase records.

This is probably a good time to remind everyone who participates in a dividend reinvestment program that complete and thorough record keeping is more than a secretarial chore, it’s an absolute necessity. This also goes if you participate in any of the staggered stock purchase programs many corporations offer through payroll deductions.

If you are audited, the Internal Revenue Service can require you to prove the taxable basis of the shares you are selling. If you can’t prove that, you could be forced to pay tax on your entire sales proceeds.

If you no longer have your dividend reinvestment records, the company may be able to help you by re-creating your holdings from its records. If you participate in a stock purchase program at work and have lost the records you need to update your payroll plan purchases, your employer might be able to help you determine how much you paid for its stock over the years. In both cases, the task may take extra time, so don’t leave it until just before you need or want to sell the shares.

Finally, with the new year approaching, this is an ideal time to pledge to straighten up your financial record keeping. It’s time-consuming, but you’ll be glad you took care of these mundane tasks when you need the records in question.

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Q I know that the tax basis of inherited property is its value on the date of death of the donor. But what if the asset left by the deceased has lost value since its acquisition? Can the recipient choose between the stepped-up basis and the original one?--A.F.

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A Assets bequeathed at death are valued as of the donor’s date of death--regardless of whether they are worth more or less than what the donor paid for them. Recipients have no choice in the matter. And if you think about it, why would the government want to give you the opportunity to claim a loss you never suffered?

Consider this example: Your aunt dies and leaves you 1,000 shares of stock. She paid $10 a share for it, but it is worth $5 a share at her death. If you sell it for $5, you would realize proceeds of $5,000, tax-free.

Why should Uncle Sam allow you an additional $5,000 “investment loss” for the stock’s decline in value? You didn’t suffer that decline and your aunt didn’t either, since she never sold the stock. The “loss,” such as it is, goes unrecognized--and is not deductible.

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Q My husband and I are arguing about how much money we keep in our checking account, which pays a bare minimum interest rate. He thinks we should have far more than we do and has accumulated nearly $25,000 in our joint checking account, about four times the level I think is needed. Who’s right? It might help you to know that we have paid off our mortgage and have over $40,000 in credit union and bank accounts.--V.S.

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A Getting involved in marital disputes is generally risky, but we won’t let our better judgment prevail. Our experts side with you: They wonder if you need to keep even $5,000 in a checking account when you already have $40,000 readily accessible in savings accounts.

The experts recommend that you keep no more than one month’s worth of expenses in a checking account. You also can keep the equivalent of about three months’ expenses in a highly liquid savings account. This should cover most emergencies and give you enough time to cash out of other investments should there be a need.

What should you do with the extra money your husband has accumulated? Our experts suggest a compromise: a no-load mutual fund that allows checking privileges and has a higher rate of return than you’d get with the interest on a bank checking account. You might consider a fund that invests in California municipal bonds, which would not be subject to state or federal tax.

Finally, our experts suggest that you consider redeploying the $40,000 you have in credit union and bank accounts to investments that offer a chance for better returns.

Without knowing more about your situation, however, it is difficult to make a more specific recommendation. A qualified personal financial advisor, preferably a fee-only certified financial planner, should be able to give you the help you need.

Carla Lazzareschi will respond in this column to financial questions of general interest. Write to Money Talk, Business Section, Los Angeles Times, Times Mirror Square, Los Angeles, CA 90053.