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New capital gains rate: zero |
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"People are used to having deduction phaseouts tied to adjusted gross income," says Scharin. "This one is geared to taxable income."
Taxable, not gross, income
Taxable income, that amount on which you figure how much you owe Uncle Sam, is reached by starting with your gross, or total, income and subtracting any adjustments (also known as above-the-line deductions), your deductions (either standard or itemized) and your personal exemptions.
Depending upon your deductions, your gross income could be substantially more than the income threshold but you'd still be eligible for the zero tax rate.
For instance, says Scharin, for the 2008 tax year, taxable income of $65,100 for a married couple with two children and who use the standard deduction translates to an adjusted gross income of $90,000.
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| Figuring adjusted gross income |
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Zero percent taxable income threshold
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$65,100
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Standard married filing jointly deduction and
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$10,900
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Personal exemptions (4 x $3,500)
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+ $14,000
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Adjusted gross income
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$90,000
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And even if your total taxable income is more than the threshold amounts, you might qualify for some tax-free capital gains. "The zero percent rate does not phase out in the same way deduction phaseouts work," says Scharin. "You're looking at other income as well, and you get the zero percent capital gains rate to the extent that your other taxable income is below that threshold."
For example, consider a married couple with $70,000 taxable income, with $60,000 of that from wages and $10,000 from capital gains. Although their taxable income exceeds their $65,100 limit, says Scharin, they pay no tax on $5,100 of the capital gains. That's the amount by which the taxable threshold exceeds their income that's subject to ordinary tax rates. And the excess $4,900 in capital gains would be taxed at 15 percent, the regular capital gains rate for taxpayers in the 25-percent-and-above brackets.
While the use of taxable instead of adjusted gross income cutoff means more investors should be able to take advantage of the no-tax law, practically speaking the change might not have that much of an effect.
"People at more moderate income brackets tend not to have a lot of capital gains," Scharin says. "They may have a mutual fund that paid out a little during the year."
Or, as Michael DeVine, a financial adviser and vice president with WealthTrust Arizona in Chandler, Ariz., points out, many zero-rate eligible individuals tend to invest primarily in tax-deferred retirement accounts, such as traditional IRAs or 401(k)s. In these cases, the elimination of the capital gains tax is of no use, as these holdings are taxed at ordinary income rates.
Kathy Harrison-Suits, an enrolled agent and vice president at Tacoma, Wash.-based Summit Capital Advisors, sees a similar pattern. "Typically what we find is people in those tax brackets are in two batches," she says. "They either have no savings and are not buying mutual funds and stocks so it has no effect on them. Or they are retirees and pre-retirees, whose incomes have dropped and they have made investments and do have capital gains within their portfolios."
Planning possibilities and problems
The zero-percent tax rate has struck a chord with retirees, a large segment of the population in DeVine's state. But it also has presented some problems. "What I don't like about this is how (some advisers) are up-selling this to retirees," DeVine says. "It helps a few people, but even then it's not that easy to digest. And as adjusted net capital goes up, it could have some consequences."
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