How to understand upcoming changes to capital gains tax

Dennis R. Mowrey, Director, Tax and Business Advisory Services, GBQ Partners LLC

With all of the debate surrounding the new health care law and its impact on business, another major issue promises to rear its head in the next few years — taxation of capital gains. Although Congress extended the Bush era cuts for another two years in December, the issue of capital gains promises to be at the forefront of political deliberation for months to come.

Tax is currently charged on capital gains, or the profits realized on the sale of a non-inventory asset that was purchased at a lower price. Almost anything owned for investment purposes or personal use are considered capital assets for income tax purposes.

“The most common capital gains are realized from the sale of stocks, bonds, precious metals and real property,” says Dennis R. Mowrey, the director of tax and business advisory services at GBQ Partners LLC.

Smart Business spoke with Mowrey about capital gains tax and some of the tax changes expected in the future.

What are some new updates with capital gains tax?

The special tax rates on long-term gains and qualified dividends expire on December 31, 2012. Starting in 2013, the tax rate on long-term gains will be 20 percent, or 10 percent for those in the 15 percent tax bracket.

Also starting in 2013, the distinction between ordinary and qualified dividends will disappear, and all dividends will be subject to the ordinary tax rates. Capital gains income will also be subject to an additional 3.8 percent Medicare tax in 2013.

What are some key things you need to understand about capital gains?

Tax rates that apply to net capital gains are generally lower than the tax rates that apply to other income. For 2010 through 2012, the maximum capital gains rate for most people is 15 percent. There are some special factors that apply to lower-income individuals, which can reduce their capital gains rates.

If your total capital losses exceed your capital gains, the excess can be deducted on your tax return and be used to reduce other income, but you are limited to an annual amount of $3,000, or $1,500 if you are married filing separately.

How are capital gains taxed, and how does this impact business?

Capital gains and losses are classified as long term and short term, depending on how long you hold the property before you sell it. Your capital gain or loss is long term if you hold the property for more than one year. Your capital gain or loss is short term if you hold it one year or less.

Long-term gains are subject to a more favorable tax rate than short-term gains. Rates for long-term gains in 2010 started at 0 percent for those in the lowest income tax bracket and topped out at 15 percent. Rates for short-term gains started at 10 percent and topped out at 35 percent. There are special rates for collectibles and the sale of certain small business stock.

A lot of times, businesses will provide dividends to their shareholders. Dividends are classified as ordinary or qualified. Qualified dividends are taxed at a 15 percent rate.

To be eligible as a qualified dividend, the dividend must meet the following two criteria:

• The dividend has to be from a domestic corporation or a qualifying foreign corporation.

• The stock must be held for more than 60 days during the 121-day period that begins 60 days before the ex-dividend date.

What special rules apply to capital gains inherited or received as gifts?

People often end up owning real estate and other property when the original owner has given that property to them. Transfers of property given before the original owner dies are gifts. The recipient of a gift does not pay any taxes or report any income when the gifted property is received. Capital gains or losses on property received as a gift are calculated with respect to the original owner’s basis in the property. When property is given, the recipient receives both the property and the property’s basis. The recipient also receives the donor’s holding period in the property for determining whether a gain is long term or short term.

Why is it important to keep good records of your capital gains and losses?

Your records help determine your capital gains and losses. Keeping good records is mandatory to be able to document and calculate the correct rates for your tax returns.

This includes making sure all items are dated, as this matters for calculating what type of gain you have — either short term or long term.

Dennis R. Mowrey is the director of tax and business advisory services at GBQ Partners LLC. Reach him at (614) 947-5273 or [email protected]