MAXIMIZING YOUR CAPITAL GAINS
Now that the 2013 tax year is over halfway completed and the stock markets have seen historical highs, many investors have some large capital gains and/or large “paper” gains. The question that often arises is “How do I keep these capital gains in my pocket?” Well, due to the recent tax law changes, this answer isn’t so simple. Let’s examine how to keep the money you earned in your pocket and out of the government’s hands.
What is a Capital Gain?
A capital gain is the amount realized on the sale or exchange of a capital asset. Capital assets include personal property items such as stocks, bonds, mutual funds, your personal residence, etc. The amount realized on the sale or exchange of a capital asset is equal to the proceeds received over the adjusted tax basis of the asset. The adjusted tax basis is, in general, equal to what you paid to acquire the asset. This amount can be increased or decreased upon certain events.
How Much Tax Do I Pay on a Capital Gain?
Because of the recent tax law changes from the American Taxpayer Relief Act of 2012, this answer has become very complicated.
The first order of business is to determine the holding period of the capital gain asset. If the asset was held for one year or less, the gain is considered short-term. Short-term capital gains are taxed at your ordinary tax rate. For example, if you fall into the 25% tax bracket, your short-term capital gain will be taxed at this rate as well.
If the asset was held for over one year, the gain is considered long-term. Long-term capital gains are taxed at a preferential rate depending on the income tax bracket you fall into. Beginning in 2013, the long-term capital gains rates have increased to 20% for taxpayers in the highest income tax brackets as follows:
- Married Filing Jointly and Surviving Spouse taxpayers over $450,000 of income
- Single taxpayers over $400,000 of income
- “Head of Household” taxpayers over $425,000 of income
For taxpayers that are above the 15% tax bracket but below the highest tax bracket, the tax rate is 15%. For those in the 10% or 15% tax bracket, the tax rate is 0%.
Are There Any New Taxes on Capital Gains Starting in 2013?
The answer to this question is maybe. One of the provisions of the recently issued Patient Protection and Affordable Care Act (“Act”) by the U.S. Supreme Court, was the institution of the Medicare Contribution Tax (“MCT”). The MCT imposes a tax of 3.8% on net investment income starting in 2013.
Taxpayers will be subject to this tax if you have Net Investment Income (“NII”) and your Modified Adjusted Gross Income (“MAGI”) is over $250,000 for married filing jointly (MFJ) taxpayers or $200,000 for Single taxpayers. The 3.8% tax is calculated as the lesser of your NII or MAGI in excess of these limitations. NII includes the following types of income: capital gains, interest, dividends, annuities, rents, royalties, passive activities, and trading of financial instruments or commodities. Please note that certain deductions related to these types of investment income may reduce the amount taxed (i.e. investment interest expense, investment expenses, etc).
So How Do I Go About Reducing My Taxes?
That is a great question! Let’s go through some potential tax planning techniques you can implement to avoid these tax increases.
- If you had large capital losses in the past when markets were at their lows, you may have been limited on the deductible loss amount you could take. It may make sense to consider selling certain highly, appreciated capital assets and realizing those “paper” gains in 2013.
- If your 2013 income is below the 15% tax bracket, it would make sense to look at your portfolio and think about selling capital gain assets at an amount that would take you right up to the 15% tax bracket threshold. For 2013, the 15% tax brackets are $70,700 for MFJ and $35,350 for Single taxpayers.
- If your income is slightly above the 15% tax bracket, then it may make sense to accelerate deductions into 2013 to move yourself into the 15% tax bracket. This strategy will need additional analysis to determine the impact of the Alternative Minimum Tax (“AMT”) however.
- If your income is hovering around the MCT or the top tax bracket, consider accelerating deductions into 2013 or implementing other strategies, such as contributing money to your retirement plan (IRA, SEP IRA, etc) in 2013. Again, the AMT will need to be considered as part of this tax planning.
- If you are married and one spouse has no other income but capital gains, it make sense to consider filing your 2013 taxes as married filing separately.
- If you have already sold some investments for large gains, considered selling some of your “loser” stocks to offset these gains. If you implement this strategy and decide to rebuy the “loser” stock sold, the “Wash Sale” rules will need to be considered.
- Consider gifting highly appreciated stock to your kids and have them sell the stock. Gift tax rules will apply and need to be considered before utilizing this strategy.
If you are currently sitting on large capital gains and/or large “paper” gains, the time to act on maximizing your capital by limiting your tax bite is now! Please contact me at 610-363-5965 for a free consultation and discussion of your personal tax situation.
Disclaimer: IRS Treasury Regulations require us to inform you that any tax advice contained in the body of this communication (including any attachments) was not intended or written to be used, and cannot be used, by the recipient for the purpose of (i) avoiding penalties that may be imposed under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.
Source: Tax Articles