The capital gains tax is a tax on profits from investments that have been recently sold. When you sell an investment at a gain, the profit becomes realized, meaning you may now owe a tax on the income you receive. The capital gains tax is found on the individual tax return on Schedule D. The percentage you are taxed at depends on your filing status and income levels, with different taxation levels between federal and state. The most common income sources for capital gains taxes are from 1099s issued by brokerage or investment agencies. Keep in mind that you can also have a capital loss, which incurs no tax and can be carried forward.
The IRS has set up a graduated tax system for the capital gains tax. For single taxpayers in 2021, you are taxed on capital gains as follows: 0% for income under $40,400, 15% for income between $40,401 and $445,850, and 20% for income over $445,850. For married filing joint taxpayers, you are taxed on capital gains at the following rates for 2021: 0% for income under $80,800, 15% for income between $80,801 and $501,600, and 20% for income over $501,600. Your income level will determine the percentage you will pay for the capital gains tax.
Capital losses are also a common occurrence. The IRS allows you to take up to a $3,000 deduction each year for capital losses. The excess can be carried forward indefinitely. Capital losses will offset any capital gains and reduce your tax liability. The IRS also differentiates between short-term and long-term capital gains and losses. Short-term is anything that is held for less than a year, while long-term is anything that is held over a year. Short-term capital gains are taxed at the ordinary income levels, while long-term capital gains are taxed at the capital gains rates.
There are a few differences in the way New York taxes capital gains compared to the federal rules. The first difference is that New York does not differentiate between short-term and long-term capital gains. Instead, New York taxes both short-term and long-term capital gains at the ordinary income rate. If you live in New York City, you may also be assessed a city income tax on the capital gains. There have been different proposals to increase the New York capital gains tax close to 40%, so be on the lookout for new regulations.
There are a few different strategies that you can take to minimize the capital gains tax. The first is to time your investments. If you know the tax rates are going to be decreasing in the next year, hold off on selling a large investment until January 1 of the next year. This will help you reduce the amount of capital gains tax you pay. Moreover, if you have a large investment you are selling at a gain, consider also selling an investment at a loss. This will help the investments to offset each other and reduce your liability.
There are many different planning strategies you can take to reduce your capital gains tax. Remember tax evasion is illegal, but tax avoidance is a legal strategy used often in tax planning. Still confused? Reach out to Amberstone Consulting to be walked through viable options for you to effectively plan for an upcoming capital gains tax.
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