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Capital gains income includes gains on the sale of stocks and other capital investments that you owned for at least one year. Capital gains also includes “long-term capital gains dividends” that you may receive from some mutual funds investments. Capital gains are taxed at more favorable “capital gains rates”, rather than at higher “ordinary” income tax rates. The capital gains rates have become more favorable.
- For lower income taxpayers in the 10% and 15% tax brackets for ordinary income, the capital gains rate has fallen from 10% to 5%. And then for just the year 2008, this rate will fall to zero.
- For higher income taxpayers, the capital gains rate has fallen from 20% to 15%. These favorable rates will end on December 31, 2007, unless future legislation extends this ending date.
Planning Opportunities: You may want to take advantage of several planning opportunities.
- Invest in Stocks and Mutual Funds: This tax law change gives you further incentive to invest in the stock market instead of bonds, certificates of deposit, and other investments that pay interest.
Example. Suppose you have a choice between investing $10,000 in a “growth” stock that increases in value by a modest 3% over one year, or a certificate of deposit that pays 3% annual interest. If you sell the stock for $10,300, you will have $300 of taxable capital gains income, while the certificate of deposit will pay $300 as taxable interest income. Further, suppose you are married and you and your spouse have a combined annual income of $100,000, with your top bracket of income at 25%. The income taxes on the interest income will be $75, and the taxes on the capital gains income will be $45. Okay, it’s not huge, but it helps a little.
- College Savings Idea: If you are saving for your child’s college education, and are fortunate over the next several years to have some investments that do well enough to result in capital gains, consider transferring them to your children before selling them.
Example. Suppose you have a stock that you purchased for $5,000 that can be sold during the next several years for $10,000. This sale will result in capital gains of $5,000. You have a modest level of income, but still high enough that you will pay capital gains taxes at the 15% rate. If you sell the stock to help pay for your child’s education, you will pay capital gains taxes of $750. Your child, as a low income taxpayer selling the same stock, will pay only $250 in capital gains taxes. Further, if your child sells the stock in 2008 when low income taxpayers have the zero capital gains rate, there would be no capital gains taxes. A savings of $750 might be worth the phone call to your broker to set up an account for your child. This idea could also work for a grandparent / grandchild situation.
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