It’s hard to make a definitive statement about how the new capital gains tax laws will affect investors. The new system is extremely daunting. Without a carefully orchestrated strategy, many investors will pay more than is necessary. To minimize your tax liability, you need to get advice from a professional tax advisor. That being said, here are some things to think about:
- There are ways to lessen the severity of the new tax hits, but the increases are significant. In order to avoid paying more than necessary, tax strategies that address individual investor needs must be in place.
- We have switched from a system with essentially two tax rates for long-term capital gains (0 percent or 15 percent, depending on your income level) to three tax tiers: 0 percent, 15 percent or 20 percent. There are also three “back door” tax increases that affect wealthier taxpayers. Calculating these additional penalties is a complicated matter. The tax changes also apply to many dividend payments and to some other types of investment income.
- Starting with the straightforward: joint filers with more than $450,000 of taxable income (or single filers earning more than $400,000) will pay a flat tax of 20 percent on long-term capital gains. Joint filers who make $72,501 to $450,000 in ordinary income (single filers earning $36,000 to $400,000) will pay 15 percent on long-term capital gains. And joint filers with less than $72,500 of taxable income (and single filers who make $36,000 or less) will pay 0 percent.
- It’s the various add-ons that make calculations confusing, resulting in a tax bill higher than you might expect. There is a new 3.8 percent tax on net investment income – unless the income derives from an actively managed business – and the new Pease limit, an increase involving itemized deductions that results in a 1 percent tax increase for taxpayers in the upper brackets (taxpayers whose income comprises dividends and long-term capital gains but no ordinary income will see about a 0.5 percent increase).
- It is not just the wealthiest taxpayers who might get an unpleasant jolt at tax time. Because of the “back door” tax increases and the phasing out of personal exemptions, joint filers who fall into the $72,501 to $450,000 income range (single filers earning $36,000 to $400,000) might cross certain income levels and find the tax rates on their investment gains rising well above the flat 15 percent.
What can you do to minimize the pain?
With the help of investment and tax professionals, there’s plenty you can do to keep as much of your hard-earned money in your pocket as the law and the tax codes allow:
Your strategy must reflect your specific situation – your age, the number of dependent children you support, financial situation, retirement plans, personal goals and long-term health care issues, etc. The new rules have introduced a level of complexity into the calculations that will require most people to get expert help. There are many planning tools that can be useful. Here are just a few:
- Remember that, in most cases, capital gains can be timed. Losses on one investment might be used to offset gains on another – even if they don’t occur in the same year. Capital losses (up to $3,000) can be deducted against ordinary income.
- Consider lowering your adjusted gross income by shifting money to IRAs, 401(k)s or health care savings accounts. The “back door” 3.8 percent tax on investment income is based on adjusted gross income (but the new long-term capital gains taxes are based on taxable income).
- Make gifts of assets rather than cash – this works for charities as well as family members.
The above commentary is general in nature and is not intended to replace the advice of your tax and investment professionals.