Q. I was very interested in your comment that, for 2008 only, people in the 15 percent and lower tax bracket would not be taxed on long-term capital gains. If this is true, I would be able to cash in some stock for a large tax savings.
A. This passing comment in a recent column has generated more than 100 letters and e-mails from readers. Nearly half said their accountants didn't know anything about such a rule.
That's amazing, considering that this tax break is part of the hotly debated 2003 law that lowered tax rates on long-term capital gains and stock dividends.
That legislation, the Jobs and Growth Tax Relief Reconciliation Act of 2003, lowered the rate on long-term capital gains to 5 percent from 10 percent for taxpayers in the two lowest tax brackets, and to 15 percent from 20 percent for all other taxpayers. (Even for taxpayers in the highest tax bracket, 35 percent, long-term capital gains would be taxed at 15 percent.) Long-term capital gains are gains on assets such as stocks, bonds and mutual funds sold after being held more than a year.
Then, for 2008 only, taxpayers in the two lowest tax brackets, which are 10 percent and 15 percent, would not be taxed at all on long-term gains.
In addition, the 2003 law cut the tax rate on qualifying stock dividends.
Before, dividends were taxed as "ordinary income" at the investor's tax bracket. Now they are taxed the same as long-term capital gains, at a 5 percent rate for taxpayers in the 10 percent and 15 percent tax brackets and at a 15 percent rate for all others. And just like long-term capital gains, stock dividends will be tax-free in 2008 for taxpayers in the two lowest brackets.
These tax breaks represent big savings opportunities for investors who plan properly. These lower rates for capital gains and dividends, unless extended by Congress, are set to expire after 2008.
At the same time, the lower rates, and particularly the zero percent rate for 2008, do not give well-heeled investors carte blanche to rack up unlimited tax-free gains.
This is the important point: The 2003 law does not mean that, as long as your other income keeps you in a lower tax bracket, you can pile up capital gains or collect unlimited dividends at preferred rates. Rather, all your taxable income, including long-term gains and dividends, is added up to arrive at your tax bracket before any preferred rates are applied.
Let's say you are a married couple filing a joint return and your taxable income in 2005, before realizing any long-term capital gains or collecting dividends, will be $55,000, which is $4,400 short of the top of the 15 percent tax bracket. If you sell stock for a long-term gain of $10,000, $4,400 of that gain would be taxed at 5 percent (the $4,400 still keeps you in the 15 percent bracket), and the other $5,600 would be taxed at the maximum 15 percent, said Mark Luscombe, principal federal tax analyst for CCH Inc., a leading publisher of tax law information.
Two other points: The 2003 law does not apply to withdrawals from deductible IRAs and employer-sponsored retirement plans, which are taxed as ordinary income; and it does not apply to the redemption of U.S. savings bonds, in which gains are considered taxable interest, not dividends or capital gains.
For those who like planning ahead, 2008 presents unique opportunities to lock in tax-free gains. My plan is to sell long-term investments in which I have a gain, as long as that gain does not push me beyond the 15 percent tax bracket. Then, assuming it is an investment I want to keep, I plan to buy it right back, establishing a higher tax basis for any future sale.
"I am not aware of anything that would prevent that strategy," Luscombe said. Unlike the so-called wash-sale rule, which disallows a tax loss if you sell an investment at a loss and buy it right away, there is no law - at least not now - that penalizes you for buying back an investment sold for a gain.
To prevent market timing, however, some mutual fund companies such as Vanguard Group have policies limiting how soon you can buy back shares of a fund you sell.
Humberto Cruz is a columnist for Tribune Media Services. E-mail him at yourmoneytribune.com.