The tax code is intentionally structured to create an incentive for you to invest your money. Not only does investing generate returns for you, but it’s also putting your money to work in growing the economy — especially when you’ve made long-term, stable investments. That’s why income from investing — which is known as “capital gains” — is often taxed at a lower rate than income from wages or a salary.
If you sell an investment that increased in value while you owned it, the difference between the sale price and the price you bought it for is considered a capital gain. And, if you’ve held the investment for longer than one year, those long-term capital gains are taxed at lower rates than normal income. However, ensuring that you maximize the capital gains tax rate benefit requires understanding what these tax rates are and when they apply.
2019 Capital Gains Tax Rates
For most people, long-term capital gains are taxed at 15 percent, but if you’re earning less than about $40,000 a year — or about $80,000 for joint filers — you’ll owe no taxes on long-term capital gains. The rate rises to 20 percent for incomes of more than $425,000 for individuals or $479,000 for joint filers.
Here are the capital gains tax brackets broken out by filing status and income:
|Capital Gains Tax Rates|
|Long-Term Capital Gains Tax Rate||Maximum Income|
|Single||Married Filing Separately||Head of Household||Married Filing Jointly|
|0%||$0 to $39,375||$0 to $39,375||$0 to $52,750||$0 to $78,951|
|15%||$39,376 to $434,550||$39,3766 to $244,425||$52,751 to $461,700||$78,752 to $488,850|
|20%||Over $434,551||Over $244,426||Over $461,701||Over $488,851|
|Information accurate as of Jan. 28, 2019.|
It’s important to note that these brackets are subject to change based on inflation, though those tend to be marginal changes and will be accompanied by a public announcement from the IRS.
Short-Term vs. Long-Term Capital Gains
To qualify for the lower long-term capital gain rates, you must own the asset for more than one year before you sell it. If you sell it after owning it for a year or less, the gain is classified as a short-term capital gain for tax purposes, which means the income is taxed at the same higher rates as your other income, such as wages and salaries.
For dividend income from an American or qualified foreign corporation, the long-term capital gains rate applies if you own common stock for at least 61 days out of the 121-day period starting 60 days before the ex-dividend date. The ex-dividend date is the last date which you must be holding a stock in order to qualify for receiving its next dividend payment. So, if you buy a stock the day after the ex-dividend date, the previous owner would be the one receiving the next dividend payout and — if you hang on to it — you’ll start receiving dividends with the payment after that.
For preferred stock, the dividend tax is at the long-term capital gains rates as long you own it for at least 91 days out of the 181-day period starting 90 days before the ex-dividend date, if the dividends are due to periods totaling more than 366 days.
Money Matters: Do I Really Have to Pay Capital Gains Tax?
Minimizing Your Tax Hit
You might be required to make estimated tax payments when you have a large capital gain. For many people who have almost all of their taxable income from wages, the income taxes withheld from their paychecks is sufficient to avoid any penalties, but to be sure, you can always use the Paycheck Checkup tool on the IRS website. Generally speaking, to avoid penalties, your withholding and estimated payments must equal at least 90 percent of your tax liability for the current year or 100 percent of what you owed in taxes for the prior year.
Capital gains are reported in the year you sell the assets, so you could consider spreading your sale over multiple years. For example, if you are planning to sell your $50,000 position in a single stock, you might sell half in December and half in January to spread the tax hit over two years.
That strategy could also help keep you below the net investment income tax threshold in a given year. The net investment income tax is a 3.8 percent tax that applies to the lesser of your net investment income — including long-term capital gains — or the amount by which your modified adjusted gross income exceeds $250,000 if married filing jointly or as a qualifying widow or widower, $125,000 if married filing separately, or $200,000 if using any other filing status.
You can also reduce your tax hit by selling some of your big gainers in a year that you have a capital loss to offset some of the income. Likewise, some people will practice a strategy known as “tax loss harvesting,” in which you consider selling losing stocks at the end of the year if you have a large capital gain. In doing so, you realize capital losses that will then offset some of your capital gains and reduce your potential tax burden.
Click through to read more about shorting a stock and why you shouldn’t do it.
More on Tax Laws
- 18 Medical Expenses You Can Deduct From Your Taxes
- If You Can’t Pass This Quiz, the IRS Is (Probably) Coming After You
- States With Inheritance Tax
- Watch: What You Need to Know About Charitable Tax Deduction
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Michael Keenan contributed to the reporting for this article.