Published Tuesday, July 15, 2014 at: 7:00 AM EDT
Remember the days before self-service when you could drive your car to a gas pump and tell the attendant to "fill 'er up"? There are good reasons to take the same approach to selling securities before the end of the year. If you're careful to fill up your lower tax brackets with long-term capital gains, you can pocket some cash and pay little, if anything, in federal income tax.
Before you start filling up tax brackets, it's important to understand the basic tax rules affecting capital gains.
Currently, there are seven federal income tax brackets ranging from 10% to 39.6%. Most "ordinary income," as well as short-term capital gains from sales of assets you hold a year or less, is taxed under this graduated rate structure. But long-term capital gains from selling securities you've owned longer than a year may be taxed at three capital gain rates:
With the tax system's graduated rate structure, even investors whose capital gains eventually will push them into the 39.6% tax bracket may be able to benefit from having part of their capital gains taxed at the lower 0% and 15% rates. That's what tax bracket management is all about.
The best way to explain the concept of filling up tax brackets with long-term gains may be with an example.
Hypothetical facts: Suppose that 2017 will be a low-income year for you because of losses from your S corporation or other business circumstances. Not including your investment income, your taxable income on a joint federal return should be only $50,000, but the upper threshold of the 15% bracket is $75,900. That leaves room for another $25,900 of income ($75,900 - $50,000) before you reach the 25% bracket—and the 15% bracket for long-term capital gains. So if you pull down a $25,900 long-term gain before year-end, the entire amount will be taxed at the 0% rate.
What's more, consider that the upper threshold for the 35% rate is $470,700. Any other long-term gains below that threshold will be taxed at the 15% rate.
Of course, there are other factors to consider, including the 3.8% surtax on net investment income. Also, be aware that capital losses offset capital gains plus up to $3,000 of annual ordinary income. But the long and the short of it all is: You can manage your tax brackets to maximize favorable tax rates for long-term capital gains.
This article was written by a professional financial journalist for Preferred NY Financial Group,LLC and is not intended as legal or investment advice.
An individual retirement account (IRA) allows individuals to direct pretax incom, up to specific annual limits, toward retirements that can grow tax-deferred (no capital gains or dividend income is taxed). Individual taxpayers are allowed to contribute 100% of compensation up to a specified maximum dollar amount to their Tranditional IRA. Contributions to the Tranditional IRA may be tax-deductible depending on the taxpayer's income, tax-filling status and other factors. Taxed must be paid upon withdrawal of any deducted contributions plus earnings and on the earnings from your non-deducted contributions. Prior to age 59%, distributions may be taken for certain reasons without incurring a 10 percent penalty on earnings. None of the information in this document should be considered tax or legal advice. Please consult with your legal or tax advisor for more information concerning your individual situation.
Contributions to a Roth IRA are not tax deductible and these is no mandatory distribution age. All earnings and principal are tax free if rules and regulations are followed. Eligibility for a Roth account depends on income. Principal contributions can be withdrawn any time without penalty (subject to some minimal conditions).
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