After years of hype over the new millennium, it finally came - without the world ending. And now that we survived January 1, 2000, we have to figure out how best to survive January 1, 2001.
Now before you click this article off, this is not an article about the year 2000 or what is going to happen in February of next year. You can look in last years' Y2K articles for that. There are about a million of them.
No, this is really about capital gains taxes and what isn’t happening in 2000, but will happen in 2001.
Here is the good news - Effective January 1, 2001, capital gains rates go down. Well, they sort of go down. This means for people in the 28% tax bracket the top long-term capital gains rate will go from 20% to 18%. If you are in the 15% bracket, your rate will go to 8%.
The bad news is there are some strings attached for those in the 28% bracket. Just so you will know how this article affects you as you read it, think about your taxable income last year and what you expect it to be in the future compared to the following points at which you hit the 28% bracket:
|Filing Status||28% Rate Starts At|
|Married, filing jointly||43,850|
|Married, filing separately||21,925|
|Head of Household||34,550|
Beginning January 1, 2001, the rich folk in the 28% bracket will be taxed only 18% on capital gains from the sale of assets. That is, if you have held the assets for 5 or more years. By the way, you must have acquired the assets on or after January 1, 2001.
One other point - most normal people, including the writer of this article, don't really think being in the 28% tax bracket makes you rich. That type of thinking is reserved for Congress.
By now, though, everyone in the 28% tax bracket should be getting the idea that the coming changes may not be all that great for you, at least in 2001. If you are, in some respects, you are right. In other respects, though, you do have some opportunities, so keep reading.
With it’s usual sense of fair play, Congress found a way to help everyone in the 28% bracket. If you are in the 28% bracket and don't want to sell, or give away, those assets you bought ten years ago, Congress is willing to let you say you purchased them on January 1, 2001. All you have to do is pay tax on the gain from the day you bought the assets until January 1, 2001.
If you think about it, it's really a pretty fair deal. You get to pay 20% tax without selling anything or making any kind of real profit.
Who says Congress doesn’t have a heart?
People in the 15% bracket do not have the same restrictions. It doesn’t matter whether they acquired the assets before or after January 1, 2001. As long as they have held the asset longer than 5 years, the gain will qualify for the 8% rate.
There is one final point to consider. All of these good benefits apply to assets that would have otherwise been taxed at the 20% rate. That means the stamp collection you sell on January 2, 2006 will still be taxed at 28% and not the 20% or 18%. There are also other special situations that apply.
By now you are probably trying to figure out if all this is good or bad news.
Set your mind at ease. It's both, but ultimately there are some good opportunities in this mixed bag of goodies.
If you are in the 28% bracket, but have kids or other people you want to benefit who are in the 15% bracket, you can always give them assets instead of cash and let them report the gain. They can then sell the assets and pay 8% instead of you paying 20% on the gain. This works because whenever you give a gift to someone, even though the gift is valued at its fair market value, for income tax purposes, the donee is treated as if he or she had bought the asset at your cost.
For example, say Frank is in the 28% bracket and owns 100 shares of SuperGrowth Company he bought 10 years ago. It cost him $1,000 but it is now worth $10,000. If he sells it and gives the money to Frank, Jr. for Spring 2001 college tuition, he just gave the IRS a $1,080 present.
How did he do that?
First of all, he will pay $1,800 in capital gains tax because his capital gain rate will be 20% on a $9,000 gain.
If Frank had given the stock to Frank, Jr., who has very little income and is in the 15% bracket, he would have reduced the rate from 20% to 8%. When Junior sells the stock, he pays only $720 in tax. That's a $1,080 savings.
Sound like a pretty good deal?
What if Frank Junior needed more than $10,000? There are a couple of alternatives. First, Frank and his wife, Mary, could each give the boy $10,000 worth of stock. This makes a total of $20,000. If it is just Frank, he could give Junior $10,000 before January 1, 2001 and another $10,000 at the beginning of 2001. Whatever Frank does, though, he has to be careful that his gifts to Frank Junior don't put Junior into the 28% bracket.
So what else can you do with the new rules coming into play?
There are a number of things you can do.
First, analyze your portfolio and see what is there. Is everything a gain? Maybe you need to write an investment letter and make a fortune off of selling subscriptions. Are there losses that most likely will remain losses? Do the losses offset the gains?
What you do next depends on how you answered these questions. If, for example, you have all gains, then you will need to decide what you expect the assets to do from now on. If you expect the assets to continue to increase in the future, you may want to make the election to pay the tax now and reduce tax in the future. It may be better to accept the 20% gain when you sell in the future.
What if you have enough losses to offset the gains? Maybe it would be better to go ahead and recognize your gains now to reduce future tax.
Even after you know the makeup of your portfolio, the ultimate answer depends on your personal financial, tax and emotional situation and goals. It also depends on everything you have already done in your personal financial planning.
Remember, once you have a new basis for your stock, it stays there. What can happen if your gain stock is Flihi Satellite Communications Corp. and you pay tax on a $1 million gain today?
The stock can increase in value, in which case you will only pay 18% tax on sales after 2005; the stock can stay flat, in which case you will pay no more additional tax; or, the stock can go down in value, in which case you will be limited to a $3,000 deduction for excess capital losses each year. If the company goes bankrupt, will you live the 333 years it will take to deduct the loss?
Since we have worked so closely together in all of these areas, get your information together and call us. Two heads are better than one and helping you with your financial life is our job. Help us serve you better by talking with us before making any final decisions.