The Jobs and Growth Tax Relief Reconciliation Act of 2003 originally reduced the tax rates on long-term capital gains, including capital gain distributions, and “qualified” dividends to 5% and 15%. It called for a 0% tax rate on such income for those in the 10% and 15% brackets for 2008 only. The Tax Increase Prevention and Reconciliation Act of 2005 extended the lower capital gain and dividend tax rates, including the 0% rate, through tax year 2010.
As it now stands most of the various tax laws passed during George W’s tenure will “sunset” in 2011, and the law will go back to that which was in existence before the hanging chads.
In discussing this topic I need to introduce you to a new tax term and acronym – Adjusted Net Capital Gains (ANCG). ANCG includes the following –
* net long-term capital gains (property held more than one year) less net short-term capital losses (property held one year or less), whether from transactions by the taxpayer himself/herself or passed through to the taxpayer on a Form K-1,
* capital gain distributions from mutual funds, and
* “qualified” dividends.
Net long-term capital gains do not include gains from collectibles, taxed at ordinary income rates up to a maximum of 28%, and “Section 1250” depreciation recapture, taxed at ordinary income rates up to a maximum of 25%.
Basically ANCG is the amount reported on Line 9b of the 2007 Form 1040 plus the smaller of the amount reported on Line 15 or 16 on the 2007 Schedule D (or the amount reported on Line 13 of Form 1040 if there is no Schedule D) less any amounts reported on Line 18 or 19 of the 2007 Schedule D and less any amount on Line 4g of the 2007 Form 4952 (Investment Interest Expense).
While ANCG is taxed separately at the special capital gain tax rates it is important to remember that this income is included in Adjusted Gross Income (AGI) as well as Alternative Minimum Taxable Income (AMTI) and can impact items of income, deduction and credit that are affected by AGI as well as cause you to become a victim of the dreaded Alternative Minimum Tax (AMT). I have discussed this issue before here at TWTP.
The ANCG income taxed at the 0% rate is that which would be taxed at the 10% or 15% rates if it were considered to be ordinary income. You begin with your net taxable income (Line 43 on the 2007 Form 1040) after deducting itemized deductions or the standard deduction and personal exemptions. You next deduct your ANCG. If the result is within the income range that is taxed at 15% than at least a part of the ANCG will be “tax-free”.
For 2008 the 15% tax bracket ends at $32,550 for Single filers and married couples filing separately, $43,650 for Head of Household, and $65,100 for joint filers. If your net taxable income less your ANCG is less than the amount that applies to your filing status you will benefit from the 0% tax rate in 2008.
Let us assume that you are single and your total net taxable income, including ANCG, is $31,000. All of your ANCG income will be tax free. If your ANCG for 2008 is $5,000 you have saved $250 in federal income tax.
But what if your 2008 net taxable income is $35,000 and you have $5,000 in ANCG? The first $2,550 of ANCG would be tax-free (taxed at 0%) and the remaining $2,450 would be taxed at 15%.
As the calculation of the tax on ANCG begins with your Taxable income, if you will have any kind of ANCG income for 2008 you may want to do whatever possible to reduce your taxable income to below the maximum 15% threshold. You can do this both by decreasing gross taxable income (reducing AGI) and increasing itemized deductions (reducing net taxable income).
My new special report MY BEST TAX ADVICE lists ways to reduce your AGI. You can further reduce your taxable income by accelerating itemized deductions like medical, employee business and investment expenses (if you will be able to exceed the applicable 7½% and 2% exclusions), state income tax (make the 4th quarter 2008 state estimated tax payment in December of 2008 instead of January of 2009 – or increase your overall estimated payments), and charitable contributions.
If your income is such that it would be impossible to reduce it enough to take advantage of the 0% tax rate you should consider “gifting” appreciated securities to a family member who will be in the lower brackets.
Congress anticipated that high-income parents would “abuse” the 0% rate by transferring appreciated assets to their children, whether to just avoid tax or to finance college costs, and changed the “Kiddie Tax” rules so that beginning in 2008 they apply to dependent children under age 19, or under age 24 if a full-time student. The investment income, including ANCG, of such dependents in excess of $1,800 will be taxed at the parents’ tax rates.
However you can gift appreciated securities to your lower-income parents and benefit from the 0% rate. Let’s say you normally contribute $10,000 per year toward the support of your retired parent(s), whom you are unable to claim as dependents, and you plan to sell stock that will produce a 50% long-term capital gain.
Instead of giving your parent(s) $10,000 in cash, or directly paying $10,000 of their bills, you can gift shares of the stock you plan to sell with a current value of $10,000. Your parent(s), who will be in the 10% bracket or lower half of the 15% bracket, can sell the stock, pocket the $10,000, and pay 0% tax on the $5,000 in capital gains. You have saved $750 in federal income tax.
Here is another thought. The “wash sale” rules only apply to the sale of stock or mutual fund shares that results in a loss. As far as I know there is nothing to prevent a taxpayer who will pay 0% tax on ANCG is 2008 from selling 100 shares of a stock for a net long-term capital gain on Monday and then on Tuesday turning around and buying back 100 shares of the stock. However, I am not 100% sure about this. I will do some additional research to verify that this is possible – so don’t do it until you hear more from me!