Can Capital Gains Push You into a Higher Tax Bracket?
Making Money on your money sounds great until you have to pay taxes.
The federal capital gains tax rate is 0%, 15% and 20%. This is lower than the tax rate on ordinary income.
To determine your capital gains tax rate, you begin with your ordinary income. Then add your capital gains to it. Where does this total fall in the range for capital gains tax bracket?
(See Table below)
| IRS Tax Rate: | Single Taxpayers | Married Filing Jointly | Heads of Household |
| 0% | $0 – $39,375 | $0 – $78,750 | $0 – $52,570 |
| 15% | $39,376 – $434,550 | $78,751 – $488,850 | $52,571 – $461,700 |
| 20% | $434,551 or more | $488,851 or more | $461,701 or more |
A married couple has ordinary income of $70,000. They sold stock and have a capital gains of $10,000. The first $8,750 of gain is taxed at 0%. The remaining $1250 is taxed at 15%.
When calculating your net capital gains, you add all your capital gains and subtract your losses.
For example, you have capital gains of $10,000 but some losses totaling $6,000. Your net capital gain is $4,000.
Let’s change that example to a gain of $10,000 and a loss of $15,000. You have a net capital gain loss of $5,000.
However, you are restricted to taking only $3,000 of losses in a single tax year. The remaining $2,000 of loss is carry forward to the following year.
Steps to Help Minimize Taxes on Capital Gains
Avoid Short Term Sales
Not all sales of investments get the lower capital gains rate. Only those that have been held for more than 1 year or “long term.” Investments bought and sold within 12 months are short term. The ordinary income rate applies to them.
Be careful in rebalancing your portfolio.
Investments within portfolios grow at different rates. Periodically, rebalancing is needed. Selling at the “high” on some investments and buying at the “low” on other investments. Unfortunately, ‘selling’ causes a taxable event unless it is in a tax deferred account like an IRA.
Not rebalancing to avoid taxes allows the portfolio to ‘drift’ in its objective.
Another more tax efficient means to rebalancing is to ‘cross reinvest’ dividends and capital gains disbursements. You are already going to pay taxes on those disbursements. Rather than reinvest in the same investment which is standard, redirect the investments to a different investment.
Using Exchange Traded Funds (ETFs)
Mutual Funds is a pooling of monies to buy and sell stocks or bonds. There is potential capital gains exposure in mutual funds. By law, mutual funds have to disburse the majority of capital gains. As an investor you have no control over this.
Exchange traded funds (ETFs) operate similar to mutual funds in the pooling of money. However, ETFs buying and selling is structured as 1031 exchanges. So few of the transactions result as taxable. You have more control over when you recognize capital gains.
Use Tax Advantage Accounts
Tax advantaged accounts are like an umbrella and shelter your capital gains activities and dividends from taxes. IRAs, ROTH, 401(k), 403(b) are a few types of accounts that are tax advantaged.
However, with the exception of the ROTH, disbursements from these types of accounts are taxable – at ordinary income rates.
Tax Harvesting
Do you have capital gains that have accumulated over the year? You may consider selling positions in your portfolio that have unrealized losses. These losses can offset the capital gains.
Use this technique with caution. You don’t want the ‘tail wagging the dog.’
For illustrative purposes only. This material is intended to provide general financial education and is not intended as tax or legal advice and may not be relied upon for purposes of avoiding any Federal tax penalties. Individuals are encouraged to seek advice from their own tax or legal counsel.
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