Linda Stern of Reuters wrote about some of the less well known tax breaks in the proposed tax cut extension legislation before Congress.
She linked to an analysis of the Senate bill by the Joint Committee on Taxation.
One item of interest to readers of this blog is that the 0% [long term] capital gains tax rate will be extended for two more years, i.e. 2011 and 2012.
How can [long term] capital gains tax rate be 0%? Isn’t it 15%? It’s 15% if you are in 25% federal income tax bracket or above. It’s 0% if you are in the 15% tax bracket or below. For the latter group, the [long term] capital gains tax rate has been zero in 2009 and 2010. Now it’s going to stay at zero for two more years. Sweet!
If you belong to this group, there’s still a limit on how much you can sell and pay zero [long term] capital gains tax. Only those [long term] gains that, when added to your regular income, still put you in the 15% bracket or below are taxed at 0%.
For example, if you are married filing jointly and your taxable income before [long term] capital gains is $40,000, you can generate up to $28,000 worth of [long term] capital gains and not pay any federal capital gains tax, because the top of the 15% federal tax bracket for married filing jointly is $68,000 ($34,000 for single). Note the relevant number is your taxable income, not gross. Taxable income is after all deductions and exemptions.
For a retiree, this is a perfect way to reset the cost basis in one’s taxable account. If you have legacy positions you no longer want but you didn’t want to sell because of [long term] capital gains, you can sell them now and buy what you really want. If you still like the investments, sell and immediately buy back the same positions. No federal [long term] capital gains tax. The tax cost basis will be higher, which means lower [long term] capital gains tax in the future when the rate isn’t zero.
Linda Stern mentioned in her article gifting appreciated stocks (or mutual fund or ETF shares) to elderly parents who are in a low tax bracket eligible for 0% [long term] capital gains tax. When you gift stocks or fund shares, the recipient gets your original cost basis. The elderly parents can sell the shares for a [long term] gain and pay no [long term] capital gains tax. If the parents feel generous, they can make a contribution to your kids’ 529 plan. Just saying …
State income tax can be a spoiler to this nice perk. Most states don’t have a special tax rate for capital gains. If you are in a high-tax state such as Oregon, although federal [long term] capital gains tax is 0%, the state of Oregon will still tax the gains at 9%. But considering it’s normally 9% plus federal [long term] capital gains tax, 9% is still a very good deal.
A reader brought to my attention that it can be more complicated if you receive Social Security benefits. Additional income can make more Social Security benefits taxable. It’s best to estimate the effects of realizing capital gains with a tax calculator. With Intuit’s TaxCaster online tax calculator, I see a couple, both 65 years old, receiving $30,000 in Social Security benefits, can generate $60,000 in long term capital gains and pay less than $500 in federal income tax. What a deal!
I must say our current policies are very friendly to retirees who have more liberty in managing their income. I just hope the policies will stay friendly when I retire.