We often see eye-catching e-mail advertisements that promise to divulge strategies that will help us (and our clients) reduce our taxes. Often, the e-mails are scams or propose illegal schemes.
However, there is an opportunity created by the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA) that is legal. For taxpayers with income below certain levels, there is now a zero-percent capital gains tax in effect for 2008, 2009, and 2010. For single taxpayers the income level is $32,550, and for married filers it’s $65,100. This presents a fantastic planning opportunity for the right taxpayers-and the income levels are less limiting than you might think.
If we’ve captured your interest, then please read on.
First, it’s important to understand that only long-term capital gains and qualified dividends are eligible for the zero-percent tax rate. BWFA’s coordinated tax, planning, and investment services help you identify the opportunities.
Second, the income test for the tax break is measured by taxable income. This is your income after you’ve deducted itemized or standard deductions and personal exemptions. This is very generous because it effectively raises your income threshold. For example, a married couple may have $100,000 in income and $35,000 of itemized deductions and personal exemptions. That makes their taxable income $65,000-they qualify. A single person would qualify under the same scenario with a pre-deductions income of $67,550.
There is even better news. Even if your taxable income exceeds the threshold, you can still qualify for zero capital gains tax on the gains that are included in income up to the threshold amount. An example will illustrate.
A married couple with total taxable income of $80,100 would appear not to qualify for the zero-percent capital gains tax. However, part of their income does qualify, as shown in the table below.
| Taxable income before long-term gains (filing jointly) | $40,100 |
| Capital gains income | $40,000 |
| Total taxable income | $80,100 |
| Tax on capital gains of first $25,000 (which brings Total Income to threshold of $65,100) |
$0 |
| Tax on excess capital gains of $15,000 @ 15% | $2,250 |
| Total tax on $40,000 long-term capital gains | $2,250 (equiv. to 5.6%) |
Who would benefit, and how does this work? First, you need to have modest taxable income and appreciated securities (stocks bought a long time ago for a low price that are worth significantly more now). When you sell the securities, you will incur a capital gain. Finally, you will benefit in one or more of the following ways:
- Reduce or eliminate your capital gains tax bill
- Reduce risk in your portfolio by selling a concentrated position
- Get rid of securities for which you have no purchase records (e.g., dividend reinvestment plan stock or gifted securities)
- Free up cash for other uses
Gotchas
The tax break in the JGTRRA works for people in certain circumstances. However, there are several factors that must be weighed before making a decision. In considering a client’s situation, BWFA would discuss the following considerations:
- People receiving Social Security retirement benefits will need to plan carefully. By using the tax break, the person will be receiving more capital gains income, which will cause more Social Security retirement benefits to be taxable.
- Changes in the Kiddie Tax Rules raised the age limit for children who must pay taxes at their parents’ rates to 19 (age 24 if a college student). This means that gifting stocks to your children in the hopes that they will qualify for the zero capital gains tax rate won’t work.
- If you planned to do a Roth conversion in 2010 (when the rules change), you may disqualify yourself from taking the zero capital gains tax rate. A little advance planning is necessary.
BWFA is always ready to assist you with tax planning that saves you tax dollars. Send us an e-mail or call us.