August 2013
Capital gains after ATRA: Why planning is so critical
Thanks to the American Taxpayer Relief Act (ATRA), the maximum capital gains tax rates are at their highest levels in years. What’s more, depending on your income, these rates may be higher than you think. ATRA raises the top rate to 20% but, when you factor in the new 3.8% investment tax and the itemized deduction limit and personal exemption phaseout (both of which were reinstated this year), the effective rate for high-income taxpayers is closer to 25%.
However, because you decide when to sell capital assets, you have some control over the timing of your gains and losses. Following are some planning techniques that can help reduce your tax bill.
Check your income
Capital gains planning can benefit most taxpayers, but it’s particularly important for high-income earners. Under ATRA, the 20% rate applies to those with taxable income over:
- $450,000, for joint filers,
- $400,000, for single filers,
- $425,000, for heads of households, and
- $225,000, for married taxpayers filing separately.
The 3.8% investment tax, itemized deduction limit and personal exemption phaseout kick in at lower income levels. (See the sidebar “Overview of 2013 tax thresholds.”)
Consider these 8 strategies
Certain strategies can take the sting out of higher capital gains rates. Here are eight to consider:
1. Minimize gains. The simplest way to avoid capital gains taxes is to avoid capital gains. If it makes investment sense, sell stock or other assets with smaller gains or larger losses this year, and put off selling assets that will generate large gains.
2. Know what you’re selling. If you plan to sell shares of stock or mutual funds, keep in mind that different shares of the same investment may produce different amounts of gain depending on what you paid for them. Before you sell, ask an investment advisor to identify specific shares for sale that will minimize gains.
3. Defer income. Generally, it’s best to recognize income later rather than sooner. A possible exception is if you expect to be in a higher tax bracket down the road. In that case, it may be best to recognize income now, while your tax rate is lower. Deferring income may also allow you to bring this year’s income below one or more of the tax thresholds described above.
4. Sell off stock. Suppose you file a joint tax return and expect your taxable income before capital gains to be $400,000. You also plan to sell stock that will generate $100,000 in long-term capital gain. If you sell it all this year, your taxable income will increase to $500,000. The first $50,000 of gain (up to the $450,000 threshold) will be taxed at 15%, but the remaining $50,000 will be taxed at 20%. If, instead, you sell half the stock in December 2013 and the other half in January 2014 (and other income remains constant), the entire gain will be taxed at 15% and you’ll cut your tax bill by $2,500 (5% of $50,000).
5. Harness other techniques. Ponder increasing contributions to any retirement plans and take advantage of deferred compensation programs. If you plan to sell a significant capital asset, such as a business or real estate, consider an installment sale to spread the gain over several years.
6. Manage gains and losses. Careful planning allows you to time investment moves to minimize taxes. For example, you might:
- Avoid selling appreciated short-term assets (those held less than a year), which are subject to ordinary-income rates as high as 39.6%,
- Sell short-term “losers” to offset short-term gains, if you have them,
- Time large capital gains and large capital losses to fall in the same year so they offset each other (bearing in mind that you can deduct up to $3,000 of a net capital loss against ordinary income), and
- Take losses before you take the gains for years in which you can’t bunch large gains and losses together (keeping in mind that you can carry unused losses forward to offset gains in future years, but you can’t carry them back).
7. Get charitable. Donate stock or other appreciated assets to charity rather than cash. Doing so allows you to avoid the capital gains tax and take a current charitable deduction (subject to certain limitations).
8. Give appreciated assets to your kids. Suppose you’re in the top tax bracket and you wish to give $10,000 to your daughter, who is not subject to the “kiddie tax” rules and whose taxable income is $25,000. To raise the cash, you sell $10,000 of stock that you bought for $2,000, generating an $8,000 taxable gain. If, instead, you had given the stock to your daughter, she could have sold it tax-free. Why? Because those in the two lowest tax brackets (under $36,250 for single filers in 2013) enjoy a 0% capital gains tax rate.
Set your priorities
Don’t let taxes alone dictate your investment decisions. Once you identify the right strategies, work with a financial advisor on how to implement them in a tax-effective manner. •
Overview of 2013 tax thresholds
| Status |
20% capital gains rate |
3.8% investment tax |
Itemized deduction limit / personal exemption phaseout |
| Taxable income over: |
MAGI* over: |
AGI over: |
|
| Joint filers | $450,000 |
$250,000 |
$300,000 |
| Single filers | $400,000 |
$200,000 |
$250,000 |
| Heads of households | $425,000 |
$200,000 |
$275,000 |
| Married filing separately | $225,000 |
$125,000 |
$150,000 |
| * | MAGI is modified adjusted gross income, which is adjusted gross income (AGI) plus any excluded foreign earned income. |
This material is generic in nature. Before relying on the material in any important matter, users should note date of publication and carefully evaluate its accuracy, currency, completeness, and relevance for their purposes, and should obtain any appropriate professional advice relevant to their particular circumstances.
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