Figuring capital gains tax rate; and determining stock value for estate taxes.

Figuring capital gains tax rate

Dear Tax Talk:
If I'm married and filing a joint return, what would be my capital gains tax rate if my earned income is \$10,000 and my gains or profits from stocks held over a year is \$30,000?

Is the total of earned income and profits on the sale of securities added together to select the tax bracket for determining the capital gains rate on investments held over 12 months?

Or can you have a large amount of capital gains, above the typical 15-percent tax bracket (about \$45,000) and still pay only 10 percent capital gains?

Thanks.
CRPace

Dear CRPace:
Although the maximum tax rate on long-term capital gains is 20 percent, individuals whose income is mostly long-term capital gains qualify to have a portion of the gains (or if less, all your taxable income) taxed at only 10 percent. The 10 percent rate applies to the part of the gains that falls within the taxpayer's 15-percent tax bracket. The 15-percent tax bracket applies to income up to \$43,050 for a married couple and \$25,750 if single (these amounts are for 1999, add about 3 to 4 percent to these amounts for 2000 indexing for inflation).

The amount of your taxable income that is long-term capital gains is taxed at 10 percent up to the 15-percent tax bracket amounts. Any long-term capital gains above this are taxed at 20 percent. If you look at Part IV of Form 1040 Schedule D, you'll see how the rates apply to part of your long-term capital gains in the following example. Using your example of a married couple with \$10,000 in earned income and no other deductions, I have laid out the tax at the following levels of long-term capital gains:

 Long-term Capital Gains Levels \$30,000 \$45,000 \$60,000 Earned income 10,000 10,000 10,000 Long-term capital gains 30,000 45,000 60,000 Standard Deduction (7,200) (7,200) (7,200) Exemptions (5,500 (5,500) (5,500) Taxable income, Line 19, Part IV, Schedule D 27,300 42,300 57,300 Line 20, 22 and 27 30,000 45,000 60,000 Line 29, the maximum at 15 percent 27,300 42,300 57,300 Line 37, 10 percent rate 2,730 4,230 4,305 Line 38, amounts over 15 percent bracket -- -- 57,300 Line 39 -- -- 43,050 Line 40 -- -- 14,250 Line 41, 20 percent maximum -- -- 2,850 Line 52, total tax 2,730 4,230 7,155

As you can see from the example, since all your income in the first 2 columns is long-term capital gains, the maximum rate applied to your taxable income, since it is less than your long-term capital gains, is 10 percent. In the third column, you still get the 10 percent rate on up to \$43,050 of your taxable income. In other words, you don't lose the lower rates by going up in a tax bracket, instead only the income in that bracket is taxed at the higher rate (referred to as your marginal rate).

Stock valuations for estate taxes

Dear Tax Talk:
When determining a valuation of close corporation stock for estate tax purposes, why won't the Internal Revenue Service accept book value?

Thanks.
Elizabeth

Dear Elizabeth:
It would be wishful thinking that the IRS would accept book value for estate tax purposes. For estate tax purposes, the assets of the estate are valued at fair market value at the date of death. Fair market value (FMV) is the value that a willing buyer and seller would agree on to exchange property if neither were under a compulsion to buy or sell. Book value is the difference between the assets and liabilities of the company. Since book value does not take into account, among other things, the earnings capabilities of a business, it is hardly ever indicative of the FMV of a business.

FMV for certain estate assets can be readily determined. For example, publicly traded stock is quoted every day. However, in the case of closely held stock, such as in a family business, FMV is mostly subjective. Most estates will have to hire a valuation expert to prepare a report to be submitted with the estate tax return. In most cases, the IRS will review this report and conduct an examination of the estate to determine the true value of the business. Business valuation is a great source of litigation in the estate tax area. The international accounting firm of Deloitte & Touche has some interesting articles on estate planning you may want to read.

-- Posted Oct. 10, 2000

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