Tax planning strategy: Take advantage of the ZERO capital gains tax rate

Most taxpayers know that long term capital gains are taxed at lower rates than ordinary income. For the past five years, these gains have been taxed at 15% or 5%, depending on the seller’s tax bracket. What you may not know is that starting in 2008, these gains have a ZERO tax rate if the seller is in the 15% or lower tax bracket. For 2008, the 15% tax bracket ends at the following taxable income levels:

Filing Status		Taxable Income
Single or married filing separately		$ 32,550
Head of household		43,650
Married filing jointly or surviving spouse		65,100

 

 

 

 

Please note the following:

1.     The taxable income figure represents income other than long term capital gains (wages, interest,                net business income, retirement income, etc.)

2.     The zero tax rate also applies to qualified dividends.

3.     Taxable income is not the same as adjusted gross income.

To illustrate these points, consider the following example of married taxpayers filing a joint return. They have adjusted gross income of $85,000 and two dependents. They have an investment account that earns only ordinary interest and dividends and has no stock sales. They also have the following itemized deductions:

State and local taxes		$   3,950
Real estate taxes		1,850
Mortgage interest		4,800
Charitable contributions		600
Total itemized		$ 11,200

Their taxable income and tax are calculated as follows:

Adjusted gross income		$ 85,000
Itemized deductions		11,200
Personal exemptions		14,000
Taxable income		59,800
Federal income tax		$   8,168

These taxpayers are in the 15% tax bracket and could benefit from the zero capital gains tax rate. Assume the same facts, except during 2008 they meet with their CPA and financial advisor to review their investment portfolio. As a result, they do the following:

1.       Adjust their investment mix so that they receive $500 of qualified dividends (versus ordinary dividends) in 2008.

2.       Sell various investments for a $5,000 long term capital gain and reinvest the proceeds.

Their taxable income and tax are now calculated as follows:

Adjusted gross income		$ 90,000
Itemized deductions		11,200
Personal exemptions		14,000
Taxable income		64,800
Qualified dividends		500
Capital gains		5,000
Ordinary taxable income		59,300
Federal income tax – ordinary		8,093
Federal income tax – cap gain		-0-
Total federal income tax		$   8,093

Not only has their income tax not increased as a result of these moves, it actually went DOWN $75 because the qualified dividends are not subject to tax.

Of course, the taxpayers would pay more in Ohio state income tax since there is no state capital gains tax rate. In this example, the taxpayers would pay about $250 more in state tax – still a small price to pay for locking in $5,000 of capital gains!

The zero capital gains tax rates are in effect for 2008, 2009 and 2010. After 2010, capital gains for taxpayers in the 15% tax bracket or lower will be taxed at 10%.