If you're prepared to pay higher taxes because of your income bracket -- especially if you're drawing on dividends, long-term investments, or sales of assets in the process -- then 2014 is a year to give special attention to the capital gains tax landscape.
This tax season, there's a fresh bump to net investment in play. Why is it there? The reason is tied to the Affordable Care Act, which created several new instruments -- ostensibly Medicare taxes (though in neither case does the tax revenue that they generate fuel health care directly). But regardless of the political underpinnings of the change, if you've made a profit from long-term holdings in the past tax year -- the result of some skilled portfolio management or otherwise -- devote some time to the following points.
Whether long-standing or recently introduced, you'll want the rules and thresholds in mind so that you can prepare for the federal tax implications.
Short-term capital gains are taxed as ordinary income, and when it comes to long-term investments, taxpayers in the lowest two brackets get to pay zero capital gains.
But once you're dealing with higher brackets, things start to shift. From the basics to recent additions, the following list will help paint the picture when it comes to capital gains rates in 2014.
- Lower bracket exclusions: The fiscal cliff negotiations of 2012 extended the 0% tax rate on long-term capital gains for taxpayers in the 10% and 15% tax brackets. That is, this year,married payers filing jointly with taxable income of less than $73,800 -- and single taxpayers at less than $36,900 -- pay no capital gains tax.
- Steady at 15%: Married couples with taxable income in excess of $73,800 but less than $457,600 -- and single payers making more than $36,900 but less than $405,100 -- pay capital gains at a rate of 15%.
- Getting to 20%: It's when your married taxable income exceeds $457,600 -- or your single filer income passes the $405,100 mark -- that the maximum tax rate on long-term capital gains jumps from 15% to 20%. Here's an example: A married taxpayer filing jointly with wage income of, say, $400,000 plus long-term capital gains of $200,000 will pay a 15% income tax rate on the first $57,600 of long-term capital gains and 20% on the remaining $142,400.
The surtax factor: new charges on net investment income
So, that's the bracket-related rate structure, but beyond the capital gains increase to 20%, what's in play additionally are the ways that the federal government's new surtax affects taxable dollars. The details are as follows.
- 3.8% surtax: This is the ACA-related change that affects capital gains. In 2014, married joint payers with an adjusted gross income in excess of $250,000 -- or $200,000, if single -- will pay a 3.8% surtax on all net investment income. What exactly is net investment income? No surprise, it's complicated (the definition consumes more than 100 pages in the written regulations). But think of it this way: It represents profits from sales, dividends, royalties, interest, and the like. And when it comes to numbers on your spreadsheet, this increases the maximum rate on long-term capital gains for taxpayers with taxable income in excess of $450,000 to 23.8%. Additionally, taxpayers should also note that the surtax can apply to estates and trusts. The threshold in these cases can be much lower. In tax year 2013, it was $11,950, and this year it's $12,150.
- Surtax exception: A taxpayer will not be required to pay the 3.8% surtax on the sale of stock in a subchapter S corporation -- provided the S corporation conducts a trade or business and the taxpayer materially participates in what the business does.
- Silver and gold (and capital gains): There's also a difference in the capital gains landscape when it comes to silver and gold, and similar commodities used as investments via exchange-traded funds. Collectibles such as gold and silver bullion aren't eligible for the normal long-term capital-gains rates. Rather, these collectibles are taxed at a rate of 28%. This special collectibles tax rate also applies to certain ETFs that deal with the physical commodities themselves -- examples include SPDR Gold (NYSEMKT:GLD), iShares Gold (NYSEMKT:IAU), and iShares Silver (NYSEMKT:SLV).
Attendant to all this, remember that capital gains can often be balanced by capital losses.
For example, if your portfolio is chock-full of $70 stocks and it took a hit that plunged those shares to a selling price of $60 per and you sell, then in your filing for that tax year, you can claim a $10 loss per share.
Another approach to balance capital gains with capital losses is to factor in depreciation of assets. Here, it gets nuanced pretty quickly, but a big-picture example would be that a small-business owner who has purchased, say, a garage where he conducts auto repairs, can take deductions over time. The amount of the deductions -- the capital losses -- are calculated against what the owner paid for the building itself (minus surrounding land, etc.).
Finally, you'll also want to know your state's capital gains tax parameters. Start with the website of the department of taxation (or its equivalent) where you live -- mining down to the capital gains rates and thresholds typically listed at those sites. From there, you can construct the whole picture when it comes to federal and state capital gains when you file this spring.
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James O'Brien is a contributor to WiserAdvisor.