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Tax Reform - Taxes on Capital Gains

Posted by L&H CPAs on Mar 26, 2018 4:02:11 PM

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As the Tax Cuts and Jobs Act (TCJA) worked its way through the legislative channels last year, there was some uncertainty about how short- and long-term capital gains would be taxed. The final bill, passed into law in December 2017, may affect investors in different ways. There are some aspects of the new tax law as it relates to capital gains that will be familiar to investors. However, new capital gains tax rates are not tied to your ordinary income tax bracket, which can make calculating gains more complex.

At a threshold level, short-term capital gains, defined as gains made on assets an investor owned for less than one year, are still taxed as ordinary income. And, long-term capital gains will still be taxed at the same tax rates of 0%, 15% or 20%.

Capital Gains Tax Brackets vs. Income Tax Brackets: An Imperfect Match

Because of changes in the income tax brackets under the new law, it may take a little more work to know how your capital gains will be taxed.

Short-Term Gains

Investors with short-term gains may pay a different tax rate on those gains than in previous years simply because their ordinary income tax bracket also changed.

The new tax brackets and income thresholds beginning in tax year 2018 are as follows:

Marginal Tax Rate

Single Taxpayers

Married Taxpayers Filing Joint Returns

Head of Household

Married Taxpayers Filing Separate Returns

10%

$0-$9,525

$0-$19,050

$0-$13,600

$0-$9,525

12%

$9,525-$38,700

$19,050-$77,400

$13,600-$51,800

$9,525-$38,700

22%

$38,700-$82,500

$77,400-$165,000

$51,800-$82,500

$38,700-$82,500

24%

$82,500-$157,500

$165,000-$315,000

$82,500-$157,500

$82,500-$157,500

32%

$157,500-$200,000

$315,000-$400,000

$157,500-$200,000

$157,500-$200,000

35%

$200,000-$500,000

$400,000-$600,000

$200,000-$500,000

$200,000-$300,000

37%

> $500,000

> $600,000

> $500,000

> $600,000

Source: Tax Foundation

Long-Term Gains

Under the old six-bracket income tax framework, if you were in the lowest two tax brackets, your long-term capital gains were taxed at the 0% rate. Investors whose income fell in the next four brackets were subject to the 15% capital gains rate, and the top bracket was subject to the 20% capital gains rate.

The new capital gains tax treatment isn’t tied to your ordinary income tax bracket. Instead, a separate set of income thresholds will be used to determine which of the three long-term capital gains tax rates will apply, as follows:

Long-Term Capital Gains Rate

Single Taxpayers

Married Taxpayers Filing Joint Returns

Head of Household

Married Taxpayers  Filing Separate Returns

0%

Less than $38,600

Less than $77,200

Less than $51,700

Less than $38,600

15%

$38,600-$425,800

$77,200-$479,000

$51,700-$452,400

$38,600-$239,500

20%

More than $425,800

More than $479,000

More than $452,400

More than $239,500

Source: Tax Cuts and Jobs Act

What About the Net Investment Income Tax?

The Net Investment Income Tax of 3.8% is not changing under the new tax framework.

Essentially, if you have net investment income and have modified adjusted gross income of more than the threshold amounts below, the net investment income tax will apply. If it does, you will be taxed on the smaller of your net investment income or the amount of your modified adjusted gross income over these thresholds. These amounts are not indexed for inflation.

Filing Status

Threshold Amount

Married filing jointly

$250,000

Married filing separately

$125,000

Single

$200,000

Head of household (with qualifying person)

$200,000

Qualifying widow(er) with dependent child

$250,000

Source: Internal Revenue Service

Let’s review a couple of examples of how the capital gains tax structure might affect different taxpayers.

Example 1: Chris (Entrepreneur)

Chris is an unmarried small business owner with taxable income of $176,000 in 2018. If Chris has both short-term gains and long-term capital gains, those gains should be taxed as follows:

Short-term gains will be taxed as ordinary income at 32%

Long-term gains will be taxed at the 15% capital gains tax rate

Example 2: Pat (Physician)

Pat is a married surgeon who files joint income tax returns. With taxable income of $480,000, short-term gains and long-term, the tax treatment should be as follows:

Short-term gains will be taxed as ordinary income at 35%

Long-term gains will be taxed at the 20% capital gains tax rate

How Will the Capital Gains Tax Laws Affect You?

Of course, the examples above are calculated without looking at all the financial complexities associated with high-income earners. Investors concerned about how to calculate the potential impact of the new capital gains tax rules on their situation should talk to us to discuss effective and relevant tax planning strategies.

Tags: Tax Reform

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