Year-End Tax Planning for Long-Term Capital Gains

 In Taxes

Under current tax law, investors owe no more than 15% on long- term capital gains and on qualified dividends. (Most dividends paid to investors are qualified.) Similarly, low-income investors owe 0% tax on long-term capital gains and qualified dividends. Investors can use this 0% tax rate if their taxable income— after deductions—is no more than $34,500 as a single taxpayer or no more than $69,000 on a joint tax return. The 0% tax rate is scheduled to remain in effect through 2012. However, Congress may act to abolish this special rate. In the meantime, you may be in a position to take advantage of this tax break before year-end 2011.
Help wanted
You should keep the 0% tax rate in mind if you are helping relatives to make ends meet.
Example 1: George and Meg Warner have a substantial income and live comfortably. They also help to support Meg’s widowed mother, who has a modest income. From time to time, the Warners send Meg’s mother a check for $1,000, $2,000, or more.
Instead, the Warners could give Meg’s mother appreciated securities. They could give her $20,000 worth of stock that they bought years ago for $12,000, for instance. That stock is really worth only $18,800 to the Warners, who would owe a 15% tax on an $8,000 capital gain, if they were to sell those shares.
Meg’s mother could sell the shares and owe 0% tax on the $8,000 long-term gain, as long as the added income does not push her over $34,500 in taxable income for 2011. Then she would have $20,000 to spend, which might last her for some time.
Will George and Meg face gift tax consequences? That will depend on several factors, including the amount of gifts they previously have made to Meg’s mother in 2011. The annual gift tax exclusion, which is $13,000 this year, and the current $5 million exemption for gifts not covered by the exclusion, probably will keep the Warners from owing gift tax. (For more on the gift tax, see the following example.)
Example 2: Olivia Brown has a sizable income and ample net worth. Her only child, Greg, is a schoolteacher whose wife, Natalie, stays home with their two children. The young couple has a taxable income of $30,000 a year, which barely covers their expenses, and Olivia would like to make a generous gift. Instead of writing a check, Olivia could give appreciated securities that the young couple can sell. Greg and Natalie Brown can have up to $39,000 worth of additional income Year-End Tax Planning for Long-Term Capital Gains from long-term capital gains this year and owe 0% tax.
Olivia will have to file a gift tax return if she gives Greg and Natalie more than $13,000 apiece in 2011. Those excess gifts won’t be taxed as long as Olivia’s lifetime taxable gifts are $5 million or less. The excess gifts, however, will reduce Olivia’s eventual estate tax exemption, dollar for dollar.
Assume that Olivia has never made any taxable gifts in prior years. She gives a total of $50,000 worth of securities to Greg and Natalie in 2011. The first $26,000 are covered by this year’s gift tax exclusion ($13,000 apiece), and the other $24,000 will reduce Olivia’s future estate tax exemption. Assuming an extension of current law, with a $5 million estate tax exemption, the $24,000 of excess gifts will reduce Olivia’s exemption to $4,976,000.
No kidding As covered in the August 2011 issue of the CPA Client Bulletin, the so-called “kiddie tax” limits the tax benefits of transferring appreciated securities to very young recipients. This tax applies to the unearned income of all children under age 18, many 18-year-olds, and many students under age 24. In 2011, unearned income over $1,900 reported by these “kiddies” will be taxed at the parents’ rate, so long- term capital gains are likely to be taxed at 15%, not 0%.
Therefore, if you are planning to take long-term capital gains, you may get more tax advantages by giving the appreciated assets to people not affected by the kiddie tax. In addition to retired parents and young workers, graduate students older than 23 may be able to receive these gifts, sell them by December 31, and take thousands of dollars worth of gains at the 0% rate.
The 15% solution
As mentioned earlier in this article, the future of the 0% tax rate is uncertain. Similarly, Congress might increase the current 15% tax rate on long-term capital gains for years after 2011; taxpayers with income over $200,000 may be especially vulnerable. Therefore, if your plans include selling assets held more than one year—perhaps to pay college bills—you may want to sell those assets by year-end 2011, when you can count on a 15% tax rate.