21 Jan

0% Capital Gains Rate! Can this be true?

January 21, 2008

Yes it is true!  For 2008 through 2010, the long-term capital gains* rate for some investors will drop to zero. But before you start planning a fire sale of your stocks and mutual funds, make sure you’ll be eligible for this tax break.  The zero-percent capital gains tax rate will only apply to those individuals who are in a 10% and 15% tax bracket.

Currently, the top long-term capital gains rate is 15% compared to a maximum ordinary income tax rate of 35%. Last year, those in the 10% and 15% income tax brackets qualified for a 5% capital gains rate; however in 2008 their capital gains tax disappears. To take advantage of the 0% capital gains rate, your ordinary taxable income cannot exceed $32,550 if you are single or $65,100 if you are married filing jointly (MFJ).

To arrive at ordinary taxable income, all your ordinary income (such as wages, retirement plan distributions, interest income, and social security) is reduced first by your deductions (the standard or itemized deduction and your personal exemptions).  This is before adding in any capital gains.  If this total is below $32,550 for a single taxpayer or $65,100 for a MFJ taxpayer, then some of your long term capital gains can be taxed at the 0% tax bracket.  Why only some?  Well, it depends on the amount of capital gains you have versus the amount of ordinary taxable income you have.  If you have zero ordinary taxable income, then all of your capital gains up to the two amounts listed above for single and MFJ will be taxed at 0%.  If there are excess capital gains that don’t qualify for the zero-percent tax rate, they will be taxed at 15%.

The individuals that may have been able to really benefit from this law were college age students.  Unfortunately, the new “kiddie tax” rules that take effect in 2008 have blocked shifting income from parents to their children by taxing them at their parent’s rates up to age 24.  Another unforeseen outcome of cashing in one’s stocks or mutual funds is increasing the amount of social security that is taxed by seniors.  Keep in mind that any increase in income (by creating capital gains) increases the amount of social security that is taxed.  This may inadvertently negate the benefits of a 0% tax bracket.

Again, this tax-free treatment of long-term capital gains is scheduled to apply in 2008, 2009, and 2010, but some skeptics worry that Congress may rescind the measure in future years as it searches for revenues to offset other tax changes. So if you are likely to benefit from this strategy—perhaps if you are self-employed or retired and can control the timing of your income—set your sites on 2008 to cash in on the break before it disappears.  And don’t forget to have your tax professional run the numbers first.

* To qualify for preferential long-term capital gains treatment, you must hold shares for more than a year before selling.

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