Changes to the Capital Gains Tax Rules Under the American Taxpayer Relief Act

Taxpayers scrambled to sell capital assets in 2012 anticipating changes to the capital gains tax rates. Find out what happened for 2013.

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2012 might have been the last year in which lower income taxpayers would be able to sell long-term capital assets and pay zero taxes on their profits. That's right, zero federal income taxes. This law was scheduled to expire at the end of 2012. However, under the fiscal cliff tax deal enacted on January 1, 2013, the 0% capital gains tax rate was preserved although there were other changes to tax rates for investment income (see below).

What Are Capital Assets?

Just about everything you own and use for personal or investment purposes is a capital asset. This includes things like your home and home furnishings, stocks and bonds, mutual funds, and your car. It does not include property you use in a trade or business, including business inventory.

Earning a Profit When You Sell Capital Assets

When a capital asset is sold, the difference between the basis in the asset and the amount it is sold for is a capital gain or a capital loss. "Basis" means the amount of your investment in the asset. Generally an asset's basis is its cost. You have a capital gain if you sell the asset for more than your basis. You have a capital loss if you sell the asset for less than your basis.

Example: Bill purchased 100 shares of Acme Inc. stock in 2001 for $1,000. He sold the shares in 2012 for $10,000. He has a capital gain of $9,000.

Capital gains and losses are classified as long-term or short-term. Long-term is better taxwise because the tax rate on long-term gains is lower than on short-term gains. A capital gain or loss is long term only If you own the asset for more than one year before you sell or otherwise dispose of it. If you hold it one year or less, your capital gain or loss is short term. To determine how long you held the asset, count from the date after the day you acquired the asset up to and including the day you disposed of the asset. In the example above, Bill has a $9,000 long-term capital gain because he owned the stock for more than one year.

Qualifying for the Zero Tax Rate

To encourage investment, there are usually special tax rates for long-term capital gains that are lower than the income tax rates on ordinary earned income, such as the income you earn from a job. Long-term capital gains rates have been changed frequently over the years. For the past ten years they have been very low.

There are two different long-term capital gains tax rates, depending on your income.

The capital gains rate is zero percent if your total income (including capital gain income) places you in the 10% or 15% income tax brackets. The capital gains rate is 15% or 20% (2013 rates) if your total income (including recent capital gain income) places you in the 25% bracket or higher. So, lower income taxpayers in the 10% and 15% tax brackets do not pay any federal income tax on their capital gains.

The chart below shows how much taxable income you can have in 2012 and fall within the 10% or 15% brackets which means you qualify for the zero capital gains tax rate.

 

Single

Married, Filing Jointly

10%

Up to $8,950

Up to $17,900

15%

$8,951 to $36,250

$17,901 to $72,500

Thus, in 2012 a single person will qualify for the 0% capital gains rates if he or she has no more than $36,250 in taxable income. A married couple can have up to $72,500 and qualify for the 0% rate.

What Changes Did the 2013 Fiscal Cliff Tax Deal Bring?

In 2001, the capital gains tax rates were lowered as part of the "Bush tax cuts." These lower rates were scheduled to expire on December 31, 2012. If Congress had not acted, the long-term capital gains rates would have reverted to their 2001 levels: The 0% rate would have disappeared and there would have been two rates: 10% and 20%.

Instead, on January 1, 2013, Congress passed the so-called fiscal cliff tax deal which included new capital gains tax provisions. Under the new tax law, the capital gains tax rate goes up from 15% to 20% for higher income earners (singles with income above $400,000 and marrieds filing jointly with income over $450,000). For everybody else, the capital gains tax rates remain the same. This means there is still a zero percent capital gains tax rate for those who qualify by being in the 10% or 15% income tax brackets. 

In sum, starting in 2013, the capital gains tax rate on long-term gains is:

  • 20% for singles with $400,000 or more in income and marrieds filing jointly with $450,000 or more in income
  • 15% for anyone in the 25%, 28%, 33% and 35% brackets, and 
  • 0% for anyone in the 10% and 15% tax brackets.

A new 3.8% investment tax also took effect on January 1 as part of the funding for Obamacare. Singles with income above $200,000 and marrieds filing jointly with income over $250,000 must pay a 3.8% tax on their net investment income. This is added to the regular capital gains rate. Thus, the top rate will be 23.8% for those in the $400,000/$450,000 income levels.

January 2013

by: , J.D.

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