The zero percent capital gains tax rate

One of the issues you had better deal with as year's end approaches

December 28, 2008|By Humberto Cruz

The many questions on capital gains taxes need answers before the year ends.

Some people are intrigued - and puzzled - by the zero percent tax rate on long-term capital gains for taxpayers who don't exceed the 15 percent bracket. They want to know how it works and what you need to do, or avoid doing, to qualify.

Despite the tumble in the market this year, many investors have decided to take some long-term capital gains for 2008. These are gains on the sale of assets such as stocks, bonds and mutual funds held more than a year.

Perhaps they took some gains early in the year. Or they might be sitting on paper gains on securities bought years ago. They might be receiving long-term capital gains distributions from a mutual fund even if the fund's share price is down.

For the 2008 tax year - and for 2009 and 2010 under current law - there is no tax on long-term capital gains as long as total taxable income doesn't put you beyond the 15 percent tax bracket. For 2008, that income limit is $32,550 for single filers, $43,650 for those who file as head of household and $65,100 for couples filing jointly.

The part that confuses many people is calculating taxable income. Taxable income is adjusted gross income (the number on the bottom line on the front of Form 1040) minus exemptions and deductions claimed on the back of the form. Taxpayers must include all capital gains in taxable income.

Let's say a married couple has $50,000 of taxable income in 2008 besides any long-term gains. That couple could claim up to $15,100 of long-term gains before hitting the $65,100 taxable income ceiling for the 15 percent tax bracket, and that $15,100 in gains would be tax-free.

What if they had more than $15,100 in long-term gains? The first $15,100 would still be tax-free. But any gains over $15,100 would be taxed at the maximum 15 percent rate for long-term gains.

Unlike many other tax breaks, such as eligibility for individual retirement account contributions and several tax credits, the zero percent capital gains rate depends on taxable income, not adjusted gross income.

Therefore, "making year-end charitable contributions or otherwise increasing itemized deductions can raise your eligibility for tax-free capital gains" by lowering your taxable income, said Bob Scharin, senior tax analyst for the tax and accounting business of Thomson Reuters.

Of course, lowering your adjusted gross income will lower your taxable income and could entitle you to other tax breaks. A common way to lower AGI is to contribute to a deductible IRA if you're eligible. Contributions for the 2008 tax year can be made as late as April 15, 2009.

Another way to lower total income (and AGI and taxable income) is to claim capital losses on securities sold at a loss. But losses must be used to offset any capital gains first before they can offset ordinary income, and then only up to $3,000 a year.

For example, if you have $4,000 in net tax-free long-term gains in 2008 so far, taking $4,000 in losses now would simply offset the zero-tax gains and save you nothing in capital gains taxes. Taking the losses, however, would lower your AGI. Depending on your circumstances, a lower AGI could allow other savings, including reducing or eliminating taxes on Social Security benefits.

E-mail Humberto Cruz at yourmoney@tribune.com.

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