The Jobs and Growth Tax Relief Reconciliation Act (JGTRRA) of 2003 lowered the maximum capital gains tax rate from 10% to 5% for people in the lower two tax brackets. It also lowered the rate from 20% to 15% for people in tax brackets of 25% and higher. Originally, the 0% tax rate applied to low-income taxpayers for the year 2008 only. However, the Tax Increase Prevention and Reconciliation Act (TIPRA) of 2005 extended this 0% rate for two more years.
It is important to understand the 0% capital gains tax and whether or not you qualify for it. This is particularly true if you file your own income tax return. If you qualify for this tax rate, now may be the time for you to sell those assets that have been gaining value for years. You may have avoided doing this in the past because you did not want to incur capital gains tax; but now the rules have changed.
Before you jump to conclusions, keep in mind that most taxpayers will still be taxed at the 15% maximum capital gains rate. However, lower income individuals may qualify to have their capital gains taxed at the 0% rate.
So where do you stand?
If you are in the 10% or 15% tax bracket, you will not be taxed on your capital gains. Along with this, if your taxable income is less than $32,000 (single or married filing separately), $65,100 (married filing jointly), or $43,650 (head of household), you will not be required to pay capital gains tax.
Don’t forget that your taxable income includes your capital gains. Your income may exceed the amounts mentioned above, but if your capital gains are included in this income, make sure to subtract them to determine your eligibility. If your capital gains are responsible for bringing you above the allowable threshold, you are technically still within the 10% to 15% tax bracket. In that case, your capital gains will not be taxed.
It is also important to note that 0% tax rate is only applicable to long-term capital gains, which are defined as assets held for more than one year. If you sell an asset within one year or less (i.e. short-term capital gain), you will be taxed at your regular income tax rate.
If you are helping to support your retired parents, it may be a good idea to give your parents stocks or bonds that they can sell at the 0% capital gains tax rate (rather than just giving them cash). Retirees in lower-income brackets who have investments in taxable accounts may also want to consider liquidating their assets while the 0% tax rate is still effective.
Parents who do not qualify for the 0% long-term capital gains rate may consider giving appreciated assets to their younger children to sell. But keep in mind that the “kiddie tax” may inhibit this transfer. For the year 2009, children will not be taxed on the first $950 of unearned income. The next $950 will be taxed at the children’s rate, and any unearned income above that amount will be taxed at the parent’s marginal rate.
The above information should give you a better understanding of how the 0% capital gains tax works. You should always plan ahead when making transfers or changes to your financial portfolio. It is also recommended that you consult with a tax professional because your tax liability and eligibility for certain benefits may be affected.