November 07, 2007

Planning Ahead: How to Pay Zero Taxes on Capital Gains & Dividends

For those in the 15% federal marginal tax bracket or lower next year, an excellent planning opportunity exists.

Beginning in 2008, taxpayers in these brackets will benefit from a 0% tax rate on long-term capital gains and qualified dividends. The threshold for the 15% federal bracket is $32,550 in taxable income for single and $65,100 for married taxpayers filing jointly. Qualified dividends or long-term capital gains will be taxed at 0% to the extent that this income combined with any taxable income from any other sources is under the upper threshold for the 15% bracket. Although there is debate that this tax break will be rescinded once a new Presidential administration arrives in 2009, this is currently scheduled to apply from 2008 through 2010.

Although the thresholds seem limited, bear in mind that the tax brackets are after personal exemptions and deductions. A single filer can shelter at least $8,950 and married taxpayers can shelter $17,900 in income from their federal tax return if using their standard deduction; even more if they itemize. Keep in mind that this is just for federal taxes; state taxes will still apply where applicable.

Think you may be eligible and want to take advantage of this? You can do some planning now. If you have the ability to accelerate ordinary income, you may want to recognize it now to avoid it being counted in 2008. Delaying deductions or recognizing capital losses may be more advantageous if you defer it until 2008. You may want to consider opportunities now to make this even more beneficial next year.

For those who are eligible, I really see this as an excellent opportunity for several different scenarios. For someone who has a large concentrated holding but was reluctant to sell it because of the tax consequences, this may be a great time to diversify. Others may want to hedge their tax bets by selling some high gain holdings in 2008 with no federal capital gains tax and re-deploying the assets to get a higher cost basis; then they won’t be subject to such a large tax bill when they eventually sell later at potentially higher rates. Also, children in college who have low income but high unrealized gains may want to consider selling after their junior year; this would avoid aid ineligibility problems, but before they begin working to take advantage of this. Gifting from parents or grandparents may be best coordinated with this time frame as well. Finally, I really see this as a great opportunity for those who plan to retire in 2008; these people may want to hold off on receiving Social Security benefits to keep taxable income low. This lower income would allow for a higher capacity to recognize long-term gains and then the person would use the assets subject to capital gains to cover their liquidity needs. The tax cost on the gain would be better than if you took Social Security and these delayed Social Security benefits are increased the longer you delay it. So there are all sorts of situations where this may be attractive to one who is eligible. In turn, I would turn to your financial planner and tax preparer to help coordinate and determine your eligibility and what strategies would make sense for your circumstances.

So for 2008, federal taxes on long-term gains will be “on sale.” If eligible, plan well to take advantage of it.

Posted by Jeff Bogue at 07:21 AM

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