Will Debt Derail Your Retirement? Dear Readers: Fall is in the air and that means three important things: summer vacation is over, the kids are back in school, and it's open enrollment for most employer health care offerings. While you may have mixed feelings about the first two, …Read more. Will Debt Derail Your Retirement? Dear Carrie: I'm retiring. My wife retires in four years. We don't plan to pay off our "good" home mortgage debts, seeing as they provide tax relief. But my instinct is to settle all major "bad" debts (associated with credit cards, home equity …Read more. Social Security Strategies for Spouses: Do You Know Your Options? Dear Carrie: My wife and I are both turning 66, and I understand that this is "full retirement age" according to the Social Security Administration. Should we both file on our birthdays, or is it better to wait? And could a spousal benefit help us …Read more. What Is a Living Trust? Do You Need One? Dear Carrie: Everyone I know seems to be setting up a living trust, even my friends who aren't that wealthy. My husband and I have wills, but that's it. How do we know whether we need a trust? — A Reader Dear Reader: It's usually hard to get …Read more.more articles
Who Qualifies for the Zero Percent Capital Gains Tax Rate?
Dear Carrie: If a family makes less than $68,000 a year, aren't they exempt from the capital gains tax? — A Reader
Dear Reader: With all the political discussion surrounding last December's legislation extending tax cuts, a lot of people find themselves confused on just what this means for them, particularly in terms of capital gains taxes. So, thanks for your question.
Since 2008, investors have been enjoying more favorable long-term capital gains tax rates: zero percent for investors in the 15 percent or lower tax bracket; 15 percent for those in the 25 percent tax bracket or higher. These rates were scheduled to go up after the end of 2010, but new legislation extended them for another two years, through 2012. For the record, long-term capital gains rates apply to profits made on investments held for more than one year. (Profits on investments held for one year or less are taxed as ordinary income.)
Long-term capital gains are added to regular income to determine if the zero percent rate applies. For tax year 2010, that means single taxpayers will pay tax at a 0 percent rate for long-term capital gains that fall into the income range of $34,000 or less ($68,00 for married taxpayers filing jointly). Long-term capital gain income added over those thresholds is taxed at the higher rate. These taxable income levels go up to $34,500 and $69,000 respectively in 2011.
That all seems pretty straightforward. But the confusion can come in how the capital gains you realize affect your taxable income. I'll try to clarify a bit.
FACTORING YOUR CAPITAL GAINS INTO YOUR TAXABLE INCOME
Your question concerns a family making less than $68,000 a year. And while you're correct that $68,000 is the highest 2010 income level in the 15 percent tax bracket for married filing jointly, it's your taxable income — not just how much you make — that determines what tax bracket you fall into.
Your taxable income is your total gross income minus allowable personal exemptions and deductions. Gross income includes both earned income (salary, wages, tips, commissions, bonuses, unemployment benefits and sick pay) and unearned income (dividends, interest, and the profit you make when you sell an investment — your capital gain).
So if you actually make $68,000 a year, and then sell some long-term investments at a profit, you have to add your capital gains earnings to that total.
ADDING IN STATE TAXES
So far, we've been talking about federal capital gains taxes. But many people don't realize that they also may be subject to state capital gains taxes. While most states define capital gains in the same way that the federal government does, states don't have to follow federal regulations on taxing capital gains.
Currently, only a few states have specific tax rates for capital gains. However — and this is the important point — if you live in a state that has state income taxes, long-term capital gains are more often than not treated the same as ordinary income. While you might be able to avoid paying federal capital gains taxes, your state income tax bill may go up when you pocket some capital gains on your investments, regardless of whether they're long term or short term.
Tax laws vary by state, and several states have exceptions and exclusions for various types of capital gains. It's best to talk to your accountant or tax adviser to get the complete picture for your state.
TAKING ADVANTAGE OF TODAY'S RATES
Today's low capital gains tax rates can be a real boon for lower income taxpayers who otherwise need to cash in on investments that have appreciated. This could be especially valuable to retirees. Also, higher income taxpayers can use this as an opportunity to gift appreciated stock to a lower earning adult child or grandchild, who might then be able to sell the stock and avoid the capital gains tax.
However, taxes — both federal and state — can quickly become very complicated. And it seldom makes sense to take investment action based solely on tax consequences. Before you make any selling decisions, I strongly recommend checking in with a tax professional. Realizing capital gains now may seem like a good idea — but keeping as much gain as you can in your pocket is an even better one.
Carrie Schwab-Pomerantz, CERTIFIED FINANCIAL PLANNER (tm) is president of the Charles Schwab Foundation and author of "It Pays to Talk." You can e-mail Carrie at email@example.com. This column is no substitute for an individualized recommendation, tax or personalized investment advice. To find out more about Carrie Schwab-Pomerantz and read features by other Creators Syndicate writers and cartoonists, visit the Creators Syndicate website at www.creators.com.
COPYRIGHT 2011 CHARLES SCHWAB & CO. INC. MEMBER SIPC