We all know we have to pay taxes on income earned. But many people don’t understand exactly how investments are taxed.
When you buy a security, you pay a certain price for a certain number of shares. This is called your cost basis. When you sell a security, you receive a certain price for the number of shares that you want to sell. You will either have a capital gain or loss, depending on if you sold your shares for a more or less than what you paid for them.
If you have a gain or loss, the amount of taxes you pay is based on your income and the length of time you held the security. If you don’t have any gains, net losses of more than $3,000 can be carried forward and used in subsequent years to offset gains.
A security held for less than a year is considered a short-term capital gain and is taxed at your ordinary income rate. If held longer than a year, it is considered a long-term capital gain and is taxed accordingly.
- If taxable income falls within the categories below, your capital gains rate is 0%.
- $39,375 (single/married filing separately)
- $78,750 (married filing jointly)
- $52,750 (head of household)
- If taxable income falls at or over the rates above, your capital gains rate is 15%.
- If taxable income is at or over the following categories, your capital gains rate is 20%.
- $434,500 (single)
- $244,400 (Married filing separately)
- $488,850 (married filing jointly)
- $461,700 (head of household)
The corporate income tax was first instituted in 1909, followed by the federal income tax in 1913, which included a provision for capital gains. The first capital gains tax topped out at 7%.
After World War I, capital gains were taxed at an alternate rate of 12.5% after being held at least two years. Throughout the rest of the 20th century, the gains tax varied based on the amount of time a security was held and an investor’s income.
Until about eight years ago, the “burden of proof” for reporting capital gains was on the taxpayer. As you might imagine, this resulted in a great deal of inaccurate reporting.
In fact, in 2001, there was an estimated $11 billion “tax gap” related to individual taxpayers misreporting income from capital assets (generally owned for investment or personal purposes), according to a report from the U.S. Government Accountability Office (GAO-06-603). The GAO also estimated that 38% of taxpayers who reported the sale of a security that year misreported their capital gains or losses.
In this report, issued in 2006, the GAO therefore suggested that it be required for all brokers or custodians to report to their clients and to the IRS the cost of covered securities that are sold during the tax year. It took a few years, but in 2011, the IRS issued Form 8949 for taxpayers to use in reporting more specific information about each the sale of any stocks, bonds or mutual funds – information most acquire from their broker or custodian.
Capital gains taxation was also addressed by President Obama’s Simpson-Bowles Commission (officially named the National Commission on Fiscal Responsibility and Reform) in 2011 in an effort to identify policies that would create a more sustainable fiscal future. While the commission recommended eliminating the lower tax rate for long-term capital gains in favor of a lower rate on income, the policy changes were never introduced.
Looking to the Future
The most recent development in capital gains tax came in 2018, when Director of the National Economic Council Larry Kudlow and President Trump said they would focus on a second phase of tax reform, potentially lowering the capital gains rate.
But with a current focus on other international and domestic issues, it’s unlikely we’ll see a shift in the way capital gains are taxed anytime soon. Stay on top of it, though, because any changes could affect your investments and financial goals.
Jennifer Pagliara, CFP, is an executive vice president and financial adviser at CapWealth and a proud member of the Millennial Generation. Her column speaks to her peers and anyone else that wants to get ahead financially. For more information about Jennifer, visit capwealthgroup.com. This column was published in The Tennessean on June 24, 2019.