Do you have long-term capital gains or qualified dividends? If so, there’s good news: After the Tax Cuts and Jobs Act (TCJA), you might still qualify for the 0% federal income tax rate on these types of income. The rate is only available for those with relatively low income. But, if your income is too high to benefit, your children, grandchildren or other loved ones may still be eligible for the tax savings. Here are the details.
The TCJA retains the 0%, 15% and 20% rates on long-term capital gains and qualified dividends. However, from 2018 through 2025, these rates are based on brackets that aren’t tied to the ordinary income brackets. (See “Long-Term Capital Gain and Dividend Tax Brackets under Prior Law” at right.)
For 2018, the rate brackets for long-term capital gains and qualified dividends are:
| Tax Bracket | Single | Joint | Head of Household |
|---|---|---|---|
| 0% | Up to $38,600 | Up to $77,200 | Up to $51,700 |
| 15% | $38,601 to $425,800 | $77,201 to $479,000 | $51,701 to $452,400 |
| 20% | $425,801 and up | $479,001 and up | $452,401 and up |
After 2018, these brackets will be indexed for inflation. (See the right-hand box for a proposal to index the rate for inflation.) The TCJA also retains the 3.8% net investment income tax (NIIT) for higher-income individuals, which may apply to long-term capital gains and qualified dividends. So, for 2018 through 2025, the tax rates for higher-income people who recognize long-term capital gains and dividends and are affected by the NIIT are 18.8% (15% + 3.8% for the NIIT) or 23.8% (20% + 3.8% for the NIIT).
Here are some examples of taxpayers who are still eligible for the 0% rate bracket for long-term capital gains and qualified dividends:
•Ann and Bob are a married couple who file jointly for 2018. Their adjusted gross income (including long-term capital gains and dividends) is $101,200. After claiming the standard deduction of $24,000, the couple’s taxable income is $77,200, which is the top of the 0% bracket for long-term capital gains and qualified dividends for joint filers.
•Carlyle uses head of household filing status for 2018. His adjusted gross income (including long-term capital gains and dividends) is $69,700. After claiming the standard deduction of $18,000, his taxable income is $51,700, which is the top of the 0% bracket for heads of households.
• Dana files as a single taxpayer for 2018. Her adjusted gross income (including long-term capital gains and dividends) is $50,600. After claiming the standard deduction of $12,000, her taxable income is $38,600, which is the top of the 0% bracket for long-term capital gains and qualified dividends for singles.
The adjusted gross income figures provided in these examples don’t take into account any above-the-line write-offs, such as:
•Deductible retirement account contributions,
•Health savings account (HSA) contributions,
•Self-employed health insurance premiums, and
•Deductible alimony payments.
To the extent that these hypothetical taxpayers have above-the-line deductions, their adjusted gross income could be that much higher without falling outside the 0% rate bracket for long-term gains and dividends.
Additionally, if an individual itemizes deductions — rather than taking the standard deduction — his or her adjusted gross income (including long-term capital gains and dividends) could be even higher than levels illustrated by these examples.
Is your income too high to benefit from the 0% rate on long-term capital gains and qualified dividends? You may have children, grandchildren or other loved ones who qualify for the break. If so, consider gifting them some appreciated stock or mutual fund shares. They can then sell the investments, and pay 0% tax on any resulting long-term capital gains. But there’s a hitch: Gains will be considered “long-term” only if the ownership period of the donor and the gift recipient (combined) is at least a year and a day.
Giving away stocks that pay dividends can be another tax-smart idea. As long as the dividends fall within the gift recipient’s 0% rate bracket, they’ll be federal-income-tax-free.
For 2018, the annual gift tax exclusion for each individual is $15,000 per gift recipient. For example, by making joint gifts, a married couple could give investments worth up to $60,000 to their son and daughter-in-law (combined) without incurring gift tax or dipping into the unified federal gift and estate tax exemption. For 2018, this exemption is $11.18 million (effectively $22.36 million for married couples).
Before the Tax Cuts and Jobs Act (TCJA), individuals faced three federal income tax rates on long-term capital gains and qualified dividends: 0%, 15% and 20%. Prior law (before 2018) tied the rate brackets for long-term capital gains and dividends to the ordinary income rate brackets as follows:
| Ordinary Income Tax Rate | Long-Term Capital Gains and Qualified Dividends Tax Rate |
|---|---|
| 10% or 15% | 0% |
| 25%, 28%, 33% or 35% | 15% |
| 39.6% | 20% |
In addition, under prior law, long-term capital gains and qualified dividends for high-income individuals were subject to the 3.8% net investment income tax (NIIT).
The Trump Administration is studying whether it can bypass Congress and grant a tax cut to taxpayers with capital gains. How? By taking inflation into account when figuring capital gains tax liabilities.
Currently, the capital gains tax rate is applied to the difference between the price of an asset when it’s purchased and when it’s sold. The calculation doesn’t take inflation into account. In newspaper reports, members of the administration have argued that President Trump has the authority to index capital gains for inflation. That’s because a 2002 U.S. Supreme Court ruling gives regulators the power to determine how “cost” is defined.
In a New York Times interview, U.S. Treasury Secretary Steven Mnuchin said: “If it can’t get done through a legislation process, we will look at what tools at Treasury we have to do it on our own and we’ll consider that. We are studying that internally, and we are also studying the economic costs and the impact on growth.”
The 0% tax rate on long-term capital gains and qualified dividends applies only to long-term capital gains and dividends that accumulate in taxable investment accounts (like brokerage firm accounts) and long-term gains from investment assets (like real estate) that are held outside of tax-favored retirement accounts, including traditional IRAs and 401(k) accounts.
If you have questions or want more information about whether this potentially valuable tax break could work for you or members of your family, contact your ALL CPAs tax advisor or message us below.
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