The capital gains tax rate: How it’s different than tax on other income

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In a Nutshell

Generally, you have to pay federal taxes on all your income. But some types of income are taxed differently than others. The capital gains tax rate is typically much lower than the rate you’ll pay on other income. Here are things to know about long-term and short-term capital gains.

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Income is income — or is it?

Different kinds of income may be taxed at different rates. You’ll pay one rate on income like your salary, a different rate on self-employment income, and yet another on any profit (capital gains) you get from selling assets like a home or investments.

Generally, long-term capital gains get taxed at a lower rate than ordinary income. The capital gains rate varies depending on how long you’ve owned the asset you sold for a profit.

If you’ll realize profit from selling an asset in 2018, or will be getting investment income, the capital gains tax rate may apply to you. Here’s a look at how the rate could affect your 2018 income.


What are different types of taxable income?

If you’ve ever really analyzed your own tax return, you may have noticed that different types of income get taxed at different rates. Knowing how much tax you’ll pay on each kind of income can help you figure out the best way to minimize your tax bill.

Ordinary income

Most income is taxed at the ordinary income rate — a set of brackets covering the tax rate you’ll pay on each portion of your income. Here are the ordinary income tax brackets and rates for 2018.

Rate Single Filer Married Filing Jointly Head of Household Married Filing Separately
10% $0–$9,525 $0–$19,050 $0–$13,600 $0–$9,525
12% $9,526–$38,700 $19,051–$77,400 $13,601–$51,800 $9,526–$38,700
22% $38,701–$82,500 $77,401–$165,000 $51,801–$82,500 $38,701–$82,500
24% $82,501–$157,500 $165,001–$315,000 $82,501–$157,500 $82,501–$157,500
32% $157,501–$200,000 $315,001–$400,000 $157,501–$200,000 $157,501–$200,000
35% $200,001–$500,000 $400,001–$600,000 $200,001–$500,000 $200,001–$300,000
37% $500,001+ $600,001+ $500,001+ $300,001+

Ordinary income includes wages and salaries, income from a business or rental property, most interest payments and some dividends.

FAST FACTS

How do marginal tax brackets work?

If you fall into a tax bracket over 10%, you actually have more than one tax rate applied to your income. You’ll only owe a given percentage of your income on the portion that’s within each tax bracket. For example, if you earn $35,000 as a single person, you wouldn’t owe 12% on all your income. You’d owe 10% on your income up to $9,525, and then 12% on your income between $9,526 and $35,000. Learn more about tax brackets here.

These tax brackets are indexed for inflation, meaning they are adjusted up or down each year in response to inflation or other factors, like wage growth. Indexing avoids the “bracket creep” that occurs when inflation drives a taxpayer’s income into a higher tax bracket, resulting in higher income taxes but no real increase in purchasing power.

Capital gains

The IRS considers almost everything you own, including real estate, personal items and investments, as capital assets. For every asset, you have an “adjusted basis,” which is basically the price you paid for the asset plus any money you put into improving the asset (as in the case of a home) minus any costs you incurred (such as depreciation of a car).

When you sell a capital asset, the difference between what you received from the sale of the asset and its adjusted basis is a capital gain or a capital loss.

Capital gains and losses are classified as either long term or short term. In most cases, if you owned the asset for more than one year before the sale, it’s a long-term capital gain or loss. If you held it for one year or less, it’s short term.

Generally, long-term capital gains are taxed at a lower rate than ordinary income. Long-term capital gains have their own tax brackets. Here they are for 2018.

Rate Single Filer Married Filing Jointly Head of Household Married Filing Separately
0% $0–$38,600 $0–$77,200 $0–$51,700 $0–$38,600
15% $38,601 $77,201 $51,701 $38,601
20% $425,801 $479,001 $452,401 $239,501

Short-term capital gains are taxed at the same rate as ordinary income.

Qualified dividends are taxed at the same rate as long-term capital gains. For qualified dividends to be eligible for the maximum rate of tax on qualified dividends, all the following requirements must be met.

  • The dividends must have been paid by a U.S. corporation or a qualified foreign corporation
  • The dividends are not the type listed under “Dividends that are not qualified dividends” in IRS Publication 550
  • You meet the holding period for stock, which means you must have held the stock for more than 60 days during the 121-day period that begins 60 days before the ex-dividend date

High-income earners are also subject to the Net Investment Income Tax (or NIIT), which applies an additional 3.8% tax to investment income, including interest, dividends and long-term capital gains.

Currently, the tax brackets for capital gains are not indexed for inflation, although a bill, H.R. 6444, was introduced in July 2018 by Rep. Devin Nunes of California that would do just that.

How can I minimize my capital gains tax?

Whether your capital gains are subject to ordinary tax rates or more-favorable long-term capital gains rates, it makes sense to take advantage of strategies that can help minimize the tax you’ll pay. Here are a few you might consider.

Hold investments for more than one year

Because long-term capital gains are taxed at a lower rate than short-term capital gains, try to hold off on selling until you’re past the one-year mark.

Look for ways to reduce your income

Are you planning on selling an asset that will generate a large gain this year? It might make sense to look for ways to reduce your taxable income.

The NIIT kicks in when a taxpayer’s modified adjusted gross income, or MAGI, exceeds a threshold amount of $200,000 for single filers or $250,000 for married couples filing jointly.

If you’re over that threshold, you may be able to defer some income to the following tax year, make deductible retirement plan contributions, or claim other deductions that can bring down your MAGI below those thresholds.

Harvest capital losses

If you own some investments that aren’t performing well, you might be able to sell them at a loss and use the loss to offset your capital gains.

The capital gains tax rate is applied to your net capital gain, or the amount by which your net long-term capital gain for the year exceeds your net short-term capital loss for the year.

For example, say you had a gain of $10,000 from selling Stock A. Meanwhile, you notice that Stock B is down by $5,000. By selling Stock B, you can use the loss to partially offset the gain from Stock A, meaning you’d only owe taxes on $5,000 instead of $10,000.

What’s next for capital gains taxes?

The Trump administration and Republican-led Congress have said they’re not yet done with tax reform. In late July, the administration announced it’s considering a move to index the capital gains tax rates for inflation. Under the plan, filers would be allowed to account for inflation in determining their capital gains.

It’s anyone’s guess if the proposal will go forward to become law. But even if it does, its benefit to middle class Americans will likely be limited. That’s because “very rich people hold most assets with capital gains,” the Tax Policy Center’s Leonard E. Burman noted in a recent blog.

And the Washington Post reports that more than 86% of a capital gains tax cut would go to the top 1% of earners, 9% to the next 4% of earners and the remaining 5% to the bottom 95% of earners.


Bottom line

Having to pay capital gains tax isn’t necessarily a bad thing. It means you made money! Still, no one wants to pay more tax than they absolutely have to.

Avoiding a higher tax bill for your capital gains is not as complicated as you might think. The key is to understand the types of capital gains you might incur and to sell assets strategically to minimize the amount you have to pay. Knowing how to crunch the numbers to your advantage can help you hang on to more of your investment returns.