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Capital Gains Tax Planning

The capital gains tax is a federal tax that is imposed on capital accumulation, investment and productivity. Some of the income that is subject to capital gains tax includes the sale of an investment, a home, a family business, a farm or ranch or even a work of art.

The capital gains tax is applied on the difference between the price paid for an item and the money received from selling it, or the capital gain. The most common form of capital gain for individuals is the sale of corporate stock. The capital gains tax rate for individuals is currently at one of its lowest rates ever (15%) but is slated to rise back to 20% in 2013.

Capital gains can also be either short-term or long-term. In general, short-term capital gains arise when an asset is sold and that asset has not been held for more than a year. These gains do not get preferential tax rates and are taxed just like any other ordinary income. Long-term capital gains, on the other hand, arise from an asset that is sold that has been held for more than a year. Long-term capital gains are the gains that get taxed at the lower rate.

There is an inequality with capital gains tax due to the fact that people must pay taxes on all of their gains but are only able to deduct a portion of their losses. In general, all capital losses can be offset against capital gains, but only $3,000 of capital losses can be deducted against all other ordinary income (such as wages).

For the government, the capital gains tax payment represent 6% of personal and corporate income tax receipts and 3% of total federal revenues. There is a lot of controversy surrounding the capital gains tax and taxing people on wealth accumulation, but it actually brings in much less revenue for the federal government than most people would think. In fact, the total collections during the 1990s were between $25 billion and $30 billion a year.

In the United States, capital gains are not indexed for inflation which means that the seller pays capital gains tax on the real gain and also on the gain attributable to inflation. This is one reason that the capital gains tax is lower than regular income tax rates. In other countries, such as the United Kingdom, the capital gains tax rate is much higher (over 40%) but there it is actually indexed to inflation.

A significant amount of tax planning can be done with capital gains primarily because 1) you can control when you sell an asset (such as a stock), and 2) you can offset capital losses with capital gains in a portfolio. In working in conjunction with our clients brokers and financial planners, we can typically help lower their tax bills during the year by having them strategically time their sales of investments or offset any recognized capital gains with capital losses that may be sitting in their portfolios.

By being proactive with your investments and ensuring communication between your CPA and your financial planner, you have a significant opportunity to lower your tax bill.

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