The capital gains rate for certain taxpayers will drop to
0% for tax years 2008 through 2010. How can you take
advantage of this 0% capital gains rate?
First, let's review the capital gains rate in general.
Gains from sales of personal investments held for more than
12 months generally are taxed at the capital gains rate
which is 5% or 15%. The 5% capital gains rate is available
only to those whose ordinary income is taxed at 15% or
less. The 15% capital gains rate will remain effective
through 12/31/10 (barring any changes to the law prior to
that time). The 5% capital gains rate will continue through
12/31/07; then the rate drops to 0% for tax years 2008
through 2010.
The 15% income tax brackets will be higher in 2008 as the
IRS makes its annual adjustment for inflation, which will
be announced later this year. However, to get an idea of
who may qualify for the 15% and under brackets, currently
in 2007 a married couple filing jointly must have taxable
income (which remember is all of the taxpayer's income less
their itemized deductions) of no more than $61,300; and for
a taxpayer with a filing status as single, the cutoff is
$30,650.
Next, let's review what is a capital gain.
The reduced rates for long-term capital gains generally
apply to the "adjusted net capital gains", which include
net long-term capital gains (the excess of long-term
capital gains over long-term capital losses) less any net
short-term capital loss (the excess of short-term capital
losses over short-term capital gains). This excludes sales
of collectibles (such as art work), qualified small
business stock (also known as section 1202 stock), and
unrecaptured 1250 gains (which result from the sale of
depreciable real property). These gains also include
qualified dividend income ("QDI"), dividends from domestic
corporations that qualify for the 15% tax rate. For most
taxpayers the adjusted net capital gains is merely the sum
of net long-term capital gains from real estate, stocks,
bonds, and mutual funds, plus any QDI.
Now, let's review how to determine which capital gains rate
is used.
In order to find out which capital gains rate (5% or 15%) a
taxpayer's gains are subject to, begin with taxable income
and then subtract the capital gains received during the tax
year. Subtract the difference from the maximum tax bracket
amount (e.g., $61,300 or $30,650). The result is the
amount of capital gains subject to the 5% rate (or 0% rate
in 2008), with the remainder subject to the 15% rate.
Of course, if taxable income without capital gains is
greater then the taxpayer's 15% ordinary tax bracket, then
all of the capital gains are taxed at the 15% rate.
Conversely, if taxable income including capital gains is
less than or equal to the taxpayer's 15% ordinary tax
bracket, then all of the capital gains are taxed at the 5%
(or 0% in 2008) rate.
Let's take a look at a few examples of how the calculations
work.
1. Suppose a taxpayer filing under the "married filing
jointly" status has total ordinary income of $36,100
included in taxable income plus adjusted net capital gain
income (ANCGI) of $25,000 for a total taxable income of
$61,100. Since taxable income is less than the cutoff of
$61,300 (see above), all of the ANCGI is taxed at the 5%
rate for 2007, and would be taxed at 0% if they had this
income in 2008, 2009 or 2010.
2. Suppose, instead, that the taxpayer filing under the "
married filing jointly " status has total ordinary income
of $65,000, and ANCGI of $35,000, for a total taxable
income of $100,000. Since the ordinary portion of the
taxable income is greater than the cutoff for the lower tax
bracket, all of the ANCGI is taxed at the 15% rate.
3. Finally, let's say the taxpayer filing under the
"married filing jointly" status has ordinary income of
$43,100, and ANCGI of $60,000, for total taxable income of
$103,100. Since ordinary income is less than the maximum
taxed in the 15% regular tax bracket, part of the capital
gains will be taxed at 5% (0% for 2008). The amount taxed
in the lower bracket is $18,200 ($61,300 - 43,100). The
remaining capital gains of $41,800 [$60,000 - 18,200] are
taxed at the 15% rate.
Let's go over the cautions to consider in your planning.
Caution #1: The kiddie tax
When Congress first passed the bill to lower the capital
gains rates, there was a huge loophole. Taxpayers could
gift appreciated stocks and mutual funds to their teenage
children, who are usually in a low tax bracket. Then the
teenagers could sell the investments at the 0% rate in 2008
and pay no tax on the gains. Lawmakers took exception to
this planning, noting that the intent of the bill was to
allow retirees to pay a lower rate on investments they may
need to cash out.
In response, Congress broadened the "kiddie tax", which
kicks in when a child's investment income (such as interest
and capital gains) exceeds a certain level. This investment
income is then taxed at the parents' top marginal rate.
Currently, that level is at $1,700, so any investment
income received by children in excess of $1,700 is taxed at
their parents' tax rate. In the past, the kiddie tax
applied to children under the age of 14. It has now been
raised to include those younger than 19 and up to 24 years
old if the child is a full-time student.
Caution #2: AMT
Regardless of the potential benefits possible from the
favorable capital gains rates, be aware that the
Alternative Minimum Tax (AMT) may eliminate any potential
benefit. As a taxpayer "cashes" out investments to take
advantage of the favorable rates, the additional income,
even if qualifying for lower tax rates, could push the
taxpayer's overall income into a higher bracket, which
could trigger the AMT and effectively negate the benefits
of the lower capital gains rates. Seem complicated? It
is. We strongly recommend you review all AMT and capital
gains issues with your CPA/Tax Coach.
What are the planning opportunities? Who stands to benefit
the most from the reduced capital gains tax rate?
Adults who provide financial support to their aging or
retiring low-income parents. Gifting appreciated capital
assets such as stocks or bonds instead of cash, can be a
good way to provide them with extra income. Taxpayers can
gift up to $12,000 a year per person with no gift-tax
consequences. If married, a taxpayer and spouse may give
up to $24,000.
Retirees with investment accounts. The capital gains breaks
do not affect the withdrawals from tax-deferred retirement
savings plans (i.e., IRA's). But if the taxpayer is retired
(retiring) and owns stocks, bonds, or mutual funds, the
2008 tax year may be the time to sell.
----------------------------------------------------
Tom Wheelwright is not only the founder and CEO of
Provision, but he is the creative force behind Provision
Wealth Strategists. In addition to his management
responsibilities, Tom likes to coach clients on wealth,
business, and tax strategies. Along with his frequent
seminars on these strategies, Tom is an adjunct professor
in the Masters of Tax program at Arizona State University.
For more information please visit
http://www.provisionwealth.com
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