Tim discusses the little-known tax benefit in the US tax code of the 0% tax rate on investment income. This provision allows certain individuals to pay no taxes on their capital gains and dividend income from taxable investment accounts.
Hey everyone, Tim Doehrmann back today to chat more on limiting lifetime tax liability.
Did you know there is a way to pay zero taxes on capital gains? Yes, it is possible and, in this video, I’m going to break down the insights into a strategy that could potentially help you pay no taxes, on capital gains.
So, how can you pay 0% on your capital gains? There is a little-known tax benefit in the US tax code, often referred to as the "0% tax rate" on investment income. This provision, in effect since 2008, allows certain individuals to pay no taxes on their capital gains and dividend income from taxable investment accounts. Despite its existence for over a decade, many taxpayers are unaware of this opportunity.
As I have mentioned in other videos, there are ordinary income tax rates (the 7 bracket rates) and the more favorable rates for qualified dividends and long-term capital gains (the 3 bracket rates). These rates are lower than ordinary income tax rates and even start with a 0% tax bracket.
To qualify for the 0% tax rate in 2023, single filers need to have income below roughly $44,000, and joint-filing couples need income below just under $90,000. Also, Adjustments to taxable income, such as the standard deduction, can expand the portion of income subject to this rate. For instance, single filers could potentially have up to $58,000 of capital gains and dividends taxed at 0%, while married joint filers could have up to almost $117,000.
Utilizing the 0% rate can be beneficial for individuals experiencing lower taxable income periods, such as those between jobs or early retirees who have not yet begun taking Social Security, pensions, or IRA withdrawals.
However, not all taxpayers automatically qualify for the 0% rate. There's a stacking rule that requires eligible income to be added on top of other income, potentially reducing the benefit for higher-income individuals. As a result, careful planning is necessary to take full advantage of this tax-saving opportunity.
I talked about tax loss harvesting in another video. This is essentially tax gain harvesting, where we’re filling up a 0% bracket, by selling an investment with a long-term capital gain and then buying back the same investment if we want, in order to lock in those gains at the 0% bracket.
And why do we do this? To lower lifetime tax liabilities!
Let me give you an example of how this might work. Let’s say a married couple just retired and they’ve owned Caterpillar stock for a long time, and they want to keep owning it, but, they’re sitting on $200,000 of long-term capital gains.
Now let’s say they aren’t going to have any income in 2023 because they recently retried so, they won’t have earned income and haven’t flipped on Social Security yet, and they’re relatively young so they have over a decade before they have to take RMDs and they have a lot of cash in their bank account, so they can just use that money for living expenses this year. Well, we’re going to sell enough CAT stock to lock in $117,000 in long-term capital gains. Then we’re going to but it back the next day. So now they still own Caterpillar stock, but they just locked in a zero percent tax rate on $117,000 in long term capital gains! So, not chump change.
Sometimes people ask about the wash rule, you might be asking, “What the heck is the wash rule?” the wash rules states: if an investment is sold at a loss, and then repurchased within 30 days, the initial loss cannot be claimed for tax purposes. But the key word here, was loss, with tax gain harvesting we’re selling with a gain, so the wash rule doesn’t apply.
The decision to use the 0% rate should depend on individual circumstances and financial goals. Factors like the size of taxable retirement accounts, expected payouts, annual expenses, and federal and state taxes play a significant role in making this decision.
Younger taxpayers can also benefit from the 0% rate if they have eligible gains or dividends before reaching their peak earning years, especially if they've invested in appreciating assets.
Now, from my own perspective, being able to potentially pay 0% on capital gains can have a significant impact on your overall financial well-being, especially as you plan for retirement.
But there are a couple of things to remember:
- First, capital gains stack on top of ordinary income. In the next video, I’ll talk about what happens when you have ordinary income and then stack capital gains on top of it.
- Second, remember everyone's financial situation is unique, so it's always a good idea to consult with a financial advisor or tax professional to tailor these strategies to your specific circumstances.
Of course, we always want to pay what we owe, but we never want to leave the IRS a tip.
As always, thank you for tuning in, talk soon!
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