As the November election nears there has been more and more talk about whether the Bush-era investment-income tax cuts will be allowed to expire. Political pundits are split on the possible outcome, but all investors and businesses are recommended to make sure they take advantage this year in the event they do expire. The exemptions are based on the taxpayer’s tax bracket and apply to income earned from investments sold at a profit that have been held for more than a year and a day. These investments could be mutual funds, stock other investment vehicles. For more on this continue reading the following article from TheStreet.
Unless Congress acts, 2012 may be the last year you will be able to take advantage of the special 0% tax rate on certain investment income.
Under current law, long term capital gains and "qualified" dividends are taxed at 0% if your net taxable income falls within the 10% or 15% tax brackets, or 15% if you are in the higher brackets.
If a combination of long-term capital gains and qualified dividends pushes you from the 15% bracket into the 25% bracket, part of this income will be taxed at 0% and part at 15%.
You have a long-term capital gain if you sell an investment at a profit that you have owned for more than one year — at least a year and a day.
These special capital gain tax rates are part of the "Bush tax cuts" that are scheduled to expire on December 31, 2012. I believe that Congress will extend these cuts for 2013 by the end of this year, but if it does not the long-term capital gain tax rates will revert to 10% and 20%, and all dividends will be taxed as "ordinary income."
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If you own stock or mutual funds you have held for more than a year that have gone up in value and you will fall within the 15% tax bracket, you should consider taking advantage of the 0% tax bracket regardless of whether or not the rates will change in 2013. You should contact your tax professional and have him/her run projections to see how much potential long-term gain you could claim for 2012 at the 0% rate.
One tactic that will allow you to take advantage of the 0% rate on gains in a stock or mutual fund that you want to continue to hold on to is by using the "wash sale" rule.
You have a wash sale when you sell stock or mutual fund shares and within 30 days before or after the sale you purchase an identical, or substantially identical, block of stock or mutual fund shares. For example, on September 20th you sell 100 shares of The Flach Company, and on September 21st you buy back 100 shares of The Flach Company.
You cannot deduct a loss from a wash sale, but there is nothing in the tax code that says you cannot recognize a gain from such a sale.
Let us say that your sale of the 100 shares of The Flach Company yields a long-term capital gain of $3,000. If your net taxable income is such that you fall within the 15% tax bracket, the $3,000 capital gain will be taxed at 0% on your 2012 Form 1040. Your $2,000 gain is tax-free on the federal level. However, the gain may be subject to state income tax.
What you have done for the future is increased your "tax basis" in your investment in The Flach Company for federal and state income tax purposes. So when you do eventually sell the shares your taxable gain will be $3,000 less.
One caveat: Long-term capital gains and qualified dividends are also taxed at 0% or 15% under the Alternative Minimum Tax (AMT). But as this income is included in your AGI, excessive long-term gains could cause you to become a victim of the AMT.
So check your portfolio and see if you have any gains you could claim tax-free for 2012, and then call your tax professional.
This article was republished with permission from TheStreet.