Monday, November 16, 2015


We all know, or at least many of us know, that long term capital gains (gain on the sale of investments held more than one year and capital gain distributions from mutual funds) and qualified dividends are taxed separately at special lower rates.  Those in the 10% and 15% brackets pay 0% tax on this income, those in the 25% - 35% brackets pay 15%, and those in the top 39.6% bracket pay 20%.  And that these applies to both the “regular” income tax and the dreaded Alternative Minimum Tax (ATM). Right?
Well it ain’t necessarily so {wow! 2 Broadway musical lyric references in one post!}.

Long-term capital gains and qualified dividends are reported as taxable income on Page 1 of the Form 1040 and are included in Adjusted Gross Income (AGI).  There are a multitude of deductions and credits that are reduced, phased out, or disallowed based on one’s AGI.  These include:

  deductible traditional and spousal IRA contributions,
  the ability to contribute to a ROTH IRA,
  student loan interest,
  the deduction for tuition and fees (if extended)
  medical and dental expenses,
  charitable contributions,
  casualty and theft losses,
  miscellaneous itemized deductions,
  total Itemized Deductions,
  the deduction for personal exemptions,
  the Credit for Child and Dependent Care Expenses,
  the Credit for the Elderly or Disabled,
  the American Opportunity and Lifetime Learning education credits,
  the Retirement Savings Contributions Credit,
  the Child Tax Credit,
  the Adoption Credit,
  the Earned Income Credit, and
  Coverdell Education Savings Account contributions.      

And as AGI increases so does the taxable portion of Social Security and Railroad Retirement benefits, and the deductible loss from rental real estate is reduced or phased out.

In the case of Social Security and Railroad Retirement benefits, an additional $1.00 of AGI can increase taxable benefits by as much as 85 cents.  So capital gain and qualified dividend income for a taxpayer in the 25% bracket could be effectively taxed at 21.25%, as an additional $1.000 in such income could increase taxable income by $850.

And even $10 in such income could cause a taxpayer to lose a $2,000 deduction for tuition and fees, if extended, and cost $500 in taxes in the 25% bracket.

Even though long-term capital gain and qualified dividend income is taxed separately at the special rates under the dreaded AMT, since this income increases AGI it also increases Alternative Minimum Taxable Income (AMTI), and could reduce the amount of the allowable AMT exemption.  $1,000 of such income could increase income subject to the 26% AMT tax by $250 and cost an additional $65.00.

And we all, or many of us, know that only $3,000 in net capital losses can be currently deducted on the Form 1040.  Any excess losses are carried forward to subsequent years.  If the total net loss for 2015 was $10,000, $3,000 is deducted in 2015 and $7,000 is carried forward to 2016.  So the loss is not lost.
But this is not the case on NJ or PA state income tax returns (I don’t know of any other states offhand).  These states do not allow any carryforward of capital losses.  So the $7,000 mentioned above is truly lost when it comes to state income tax.  Actually the entire $10,000 in losses are lost – as these states have a “gross” income tax system and do not allow capital losses from the sale of investments to reduce income in other categories.  
I am not saying to avoid long-term capital gains or losses.  The first criteria for evaluating any transaction, strategy, or technique you are considering should always be financial.  Taxes are second.  Never let the tax tail wag the economic dog.  Sell a stock or mutual fund shares for the best possible price.  By postponing a sale to meet the long-term criteria or to avoid having to report the income or losses on your tax return the price of the investment could drop and give you a smaller profit or greater loss.

Just be mindful of what I have discussed above, be aware of the true cost of your capital transactions, and consider increasing estimated tax payments or withholding if appropriate.  And consider harvesting losses to offset gains or engaging in a “wash sale” of investments that would generate a gain to offset losses at year end. 

It would be a good idea to discuss actual and planned investment activity with your tax professional periodically during the year, and especially at year end. 


I am sorry – I cannot resist.

Speaking of it ain’t necessarily so.  The things that you're liable to hear from Donald Trump, it ain't necessarily so.


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