Help! What Is My Capital Gains Tax Rate?!

We are continuing to digest the new tax bill (assuming President Obama signs it today).  One of the unique features in this tax bill is, that for many taxpayers, they will not accurately know their capital gains (or qualified dividends) tax rate until they prepare their tax return.

In brief, we know the following for the 2013 tax year:

• For many lower income and middle income taxpayers who are in the 15% or lower tax bracket, their capital gains will be taxed at zero.
• For most middle income taxpayers their capital gains tax rate will be a maximum of 15% (probably income in the range of $90,000 to $200/$250,000).
• For some middle income taxpayers whose adjusted gross income (not taxable income) exceeds $200/$250,000, their capital gains tax rate will be 18.8%. which is the 15% capital gains rate plus the 3.8% Medicare surtax rate on investment income including capital gains.
• For some of these same middle income taxpayers who have major itemized deductions, each dollar of additional capital gains will wipe out part of their itemized deductions.  This will increase their capital gains rate to about 20%.
• For those taxpayers who are now in the highest marginal tax rate of 39.6% ($400/$450,000 of taxable income) with limited itemized deduction, their capital gains rate will be 23.8%, the maximum capital gains tax rate of 20% plus the Medicare surtax rate of 3.8%.
• Finally, those taxpayers in the highest tax bracket with itemized deductions, their maximum capital gains (and qualified dividend) rate will be about 25%.   This is equal to the maximum capital gains rate of 20%, plus the Medicare surtax rate of 3.8% plus about 1.2% for the phase-out of their itemized deductions.

Therefore, any taxpayer can be subject to six different capital gains tax rates depending on their overall combination of adjusted gross income and taxable income.  Income tax rates are normally applied to taxable income, however, the Medicare surtax is based upon adjusted gross income.  This is why, in many cases, we will not know your actual capital gains tax rate until we prepare the tax return.

Just think if you had to prepare a tax return by hand and you made a change in your income.  You could spend a lot time just trying to calculate your capital gains tax, let alone your other taxes.

Paul Neiffer, CPA