Explaining the Capital Gains Tax
The election of 08, and the recent stock market crash have contributed to the fact that you always hear about Capital Gains taxes almost daily in the news. Many people have asked me, “What is the Capital Gains Tax, and how does the 2008 change this?”
Here is the basic definition:
Whenever you sell an investment at a profit, you will (in most cases) owe the IRS a tax known as a capital gains tax. This is true for most investments, including mutual funds , bonds, options, collectibles, your home, or business. Capital gains are the amount by which an asset’s selling price exceeds its initial purchase price. A realized capital gain is an investment that has actually been sold at a profit. An unrealized capital gain is an investment that hasn’t been sold yet but would result in a profit if sold; the gain equals the difference between the purchase price and the selling price. The term capital gain is often used to mean realized capital gain. The opposite of a capital gain is a capital loss, which occurs when the selling price of an investment is less than the purchase price.
The IRS divides capital gains into two distinct categories, with each having different tax consequences. Long-term capital gains are gains on investments held for more than a year, while short-term capital gains are gains realized on investments that are held for a year or less. Short-term capital gains are taxed according to your income tax bracket and long-term gains are taxed at 20% if you are in the 28% or higher tax bracket, and only 10% if you are in the 15% bracket. In other words, long-term gains are subject to lower tax rates because the IRS wants to encourage long-term investing.
To determine the capital gains tax on an investment, subtract the amount paid for the investment, including any broker commissions, from the sales price to arrive at the capital gain or loss. Then take this amount and multiply it by the appropriate tax rate, which will give you the tax owed on the sale of your investment.
Another capital gains reduction strategy is through the use of a tax-deferred account, such as an IRA or 401(k). These accounts enable your investment to grow tax deferred until retirement. At the time that you start taking distributions from your IRA , or 401k, you will pay taxes based on your current income tax bracket. 401k Plans, IRA’s, Roth IRA’s, and Annuities, are all vehicles that enable you to gain the tax deferred status on your investments.
What the 2008 Election Means for the Future of the Capital Gains Tax
Investors can expect higher tax rates post-2008 should a Democrat become president. Barack Obama has fervently articulated that he would like to have a pro-tax policy. Their orientation appears to be toward wealth redistribution via higher tax rates. Obama has indicated that he wanted to almost double the maximum tax rate on capital gains from 15% to 28%. The existing tax rates are going to be history after 2008 should a Democrat win control of the White House in tomorrow’s election. That message is also clear from Democrats on the House Ways and Means Committee who have already released a plan to hike personal tax rates.
On the other side is McCain, who has recently stated his support for extending the present tax-rate structure past 2010. However, McCain voted “no” on both the 2001 and 2003 tax rate reduction bills. So realistically, the likelihood of the 15% dividend tax rate and capital-gains tax rate remaining past 2008 is perhaps less than 50-50 at this point.
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