TAKING ADVANTAGE OF THE 0% TAX RATE

In my MainStreet.com article “2014 Year-End Tax Planning Strategies to Ensure a Smooth Filing” I suggest -

“If you will fall within the 10% or 15% brackets you may want to generate additional long-term capital gains to take full advantage of the 0% federal rate.”

Let me elaborate on that advice.

First - yes, that is a “zero percent” tax rate - $1,000.00 taxed at a “0”% tax rate is $0.00 in tax!

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.  The American Taxpayer Relief Act of 2012 made the lower capital gains rates permanent, and added a new 20% rate for those in the new 39.6% bracket.    

The 0% tax rate applies to Adjusted Net Capital Gains (ANCG), which is –

 

* 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%.

While ANCG is taxed separately at the special capital gain tax rate for both “regular” income tax and the dreaded Alternative Minimum Tax (AMT), it is important to remember that it is included in Adjusted Gross Income (AGI) as well as Alternative Minimum Taxable Income (AMTI), and can therefore 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). 

So in reality income separately taxed at a 0% tax rate may actually increase your tax liability.  And $1,000 taxed at a 0% tax rate may not be $0.00 in additional tax.

For 2014 the 15% tax bracket ends at $36,900 for Single filers and married couples filing separately, $49,400 for Head of Household, and $73,800 for joint filers. If your net taxable income less ANCG is less than the above amount that applies to your filing status you will benefit from the 0% tax rate.

Let us assume that you are single and your net taxable income is $35,000. All of the ANCG income included in the $35,000 will be tax-free on the federal level.  

But what if your net taxable income is $38,000 and your ANCG is $5,000.  The first $1,100 would be tax-free (taxed at 0%) and the remaining $3,900 would be taxed at 15%.

When you prepare your “preliminary” 2014 tax return and add up realized and “paper” capital gains and losses to date as part of the year-end planning process, make a note of your anticipated net taxable income and Adjusted Net Capital Gains.  If have ANCG, and you are “over the top” and within the 25% tax bracket, during the last weeks of 2014 attempt to reduce income and increase deductions to bring you within the 15% bracket, so at least some of your ANCG will be taxed at the 0% rate.

If your projected net taxable income puts you within the 15% bracket, and you have “paper” long-term capital gains in your investment portfolio, consider selling stock or mutual fund shares to generate additional long-term gain to maximize your benefit from the 0% tax rate.    

You can sell the stock or fund shares on Monday and turn around and buy them back on Wednesday. The “wash sale” rules only apply to the sale of stock or mutual fund shares that results in a loss - it does not apply if the sale results in a gain.

Before deciding to sell anything you must first consider how the additional income will impact income, deductions, and credits that are affected by increased AGI, and how it will affect your eligibility for, or the calculation of, the dreaded AMT.

 

And remember – while the additional income will be tax free on the federal return you will be paying state and local income tax on the gains.

 

You should discuss this strategy when meeting with your tax professional to map out year-end tax moves.

Any questions?

TTFN