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Health & Fitness

Don't let the tax tail wag the dog


We don't know who coined that phrase, but it was sound advice in recent years. Its basic message is to not make investment decisions based solely on the underlying tax costs or benefits. It is still good advice, but it felt a lot better when the long-term capital gains rates were 15%.
It is difficult now to avoid considering taxes. Long-term capital gains rates increased from 15% to 20% and also may be subject to the new 3.8% tax on net investment income. Plus your capital gain may be large enough to cause your itemized deductions and personal exemptions to be partially reduced, further increasing your effective rate. And many states have increased their rates in recent years. Adding this all up, based on your income, the new effective tax rate on long-term capital gains may exceed 30%.
So when do we want to consider wagging the dog?
It is largely based on your income levels, and whether your income flucuates from year-to-year.
Much like the income tax "brackets" for ordinary income, there are now similar "brackets" for long-term capital gains.  The goal is to make use of lower brackets when possible.
The long-term capital gain "brackets" are largely based on the regular tax brackets:
• Your long-term capital gains tax rate is zero-percent if you are in the 10% or 15% regular income tax brackets• Your long-term capital gains tax rate is 15% if you are under the 39.6% regular income tax bracket• Your long-term capital gains tax rate is 20% if you are in the 39.6% regular income tax bracket
The 3.8% tax on your net investment income, which includes many capital gains, applies to your net investment income to the extent your modified adjusted gross income exceeds a threshold amount, which is $250,000 if you file a joint return or are a surviving spouse, $125,000 if you are married but file a separate return, or else $200,000.
Consider these 2013 scenarios - 
1. You file a joint return and, before long-term capital gains, expect to have taxable income of $60,000. You own a stock that has a long-term gain of $10,000. You could sell the stock and pay no federal tax on the gain. You could immediately buy back the stock and have a tax basis that is $10,000 higher. Then, in the future when you may be in a higher tax bracket, you could sell the stock and have no tax on the $10,000. Absent this strategy, your future tax on the $10,000 could exceed $3,000.2. You file a joint return and, before long-term capital gains, expect to have taxable income of $200,000. You own a stock that has a long-term gain of $50,000. In 2014 you expect to have taxable income that exceeds $250,000. You could sell the stock in 2013 and pay federal tax on the gain of $7,500 (15%), or sell the stock in 2014 and pay federal tax of either $9,400 (the 15% rate plus the 3.8% tax on net investment income) or $11,900 (a 20% rate plus the 3.8% tax on net investment income) . You definitely want to "wag the dog" under the first scenario above. You may incur a broker 's commission, but otherwise there  is no cost to eliminate or reduce future taxes. This tactic most often applies to young couples or business owners with income that flucuates from year-to-year.
The second scenario is more problematic as taking advantage of the 15% rates still  involves a substantial tax payment. It is a tactic, depending on your overall financial picture, worth considering.
If you have questions about this subject, or other tax matters, please contact us at info@bkl-cpa.com

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