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Planning for the
New "Zero Percent" Tax Bracket
This issue of The
Wealth Counselor addresses a law change that is important to
all wealth planning professionals and their clients.
Beginning January 1, 2008 and continuing through at least
2010, a zero tax rate may apply to long-term capital gain
and dividend income that would otherwise be taxed at the
regular 15% and/or 10% rates. The new zero tax rate is
available to the extent that the taxpayer's other taxable
income minus exemptions and deductions is less than a
specified amount.
The new zero tax rate thus creates the opportunity for
eligible clients to sell certain appreciated assets at no
tax cost. By coordinating their efforts to ensure that
clients take advantage of this opportunity, the planning
team can preserve more of the client's investible assets or
provide resources to fund implementation of the planning
team's recommendations.
The Zero Tax Rate
The zero tax rate applies to eligible individual taxpayers
who have "adjusted net capital gain." Adjusted net capital
gain is the sum of:
Net capital gain (generally the excess of net long-term
capital gains other than collectibles gain, gain taxed on
sales of certain small business stock under IRC Sec. 1202,
and unrecaptured IRC Sec. 1250 gain over net short-term
capital losses, subject to certain limitations),
plus
Qualified dividend income (generally dividend income from
domestic corporations and qualified foreign corporations,
including dividends from U.S. possessions corporations and
corporations eligible for benefits of a comprehensive income
tax treaty with the U.S. that includes an exchange of
information program; dividends that are not qualified
include dividends from foreign investment companies,
dividends from stock held for short periods, and payments in
lieu of dividends).
Planning Tip: The zero tax rate does not apply
to net capital gains and qualified dividend income of
non-grantor trusts, estates, and C corporations.
Planning Tip: The zero tax rate does not apply
to collectibles gain or gain taxed on sales of certain
small business stock under IRC Sec. 1202 (both taxed at
a maximum rate of 28%), or to unrecaptured IRC Sec. 1250
gain (taxed at a maximum rate of 25%).
Who Gets the Zero Tax Rate?
For tax years beginning January 1, 2008, the zero tax
applies to individuals' adjusted net capital gain to the
extent that it does not exceed:
the threshold for the taxpayer's 25% income tax bracket,
minus
the taxpayer's taxable income other than adjusted net
capital gain.
Planning Tip: Stated another way, the zero rate
only applies to adjusted net capital gain to the extent
the taxpayer's other taxable income minus exemptions and
deductions is below the bottom of the 25% income tax
bracket for that taxpayer.
For 2008, the threshold for the 25% income tax rate is:
- $32,550 for single taxpayers and married taxpayers
filing separate returns;
- $65,100 for married taxpayers filing joint returns
and surviving spouses; and
- $43,650 for heads of households.
Thus, taxpayers whose ordinary income plus net capital gains
and dividend income not included in adjusted net capital
gain exceeds their respective 25% income tax thresholds will
not be eligible for the zero rate. Conversely, if their 2008
ordinary income plus net capital gains and dividend income
not included in adjusted net capital gain is less than their
respective 25% income tax threshold, the zero tax rate
applies.
Examples
Example 1. Tom and Mary Taxpayer file jointly and have
taxable income of $60,000 in 2008, comprised of $50,000 of
ordinary income and $10,000 of adjusted net capital gain.
Since the Taxpayer's ordinary income is less than the 25%
income tax threshold, the zero tax rate would apply to all
of their $10,000 adjusted net capital gain.
Example 2. The Taxpayers have taxable income of $75,000 in
2008, comprised of $50,000 of ordinary income and $25,000 of
adjusted net capital gain. In this case, $15,100 (the
difference between their 25% income tax threshold and their
ordinary income of $50,000) would be subject to the zero tax
rate, and the balance, $9,900 ($75,000 - $50,000 - $15,100),
would be subject to the 15% rate.
Example 3. The Taxpayers have taxable income of $75,000 in
2008, comprised of $70,000 of ordinary income and $5,000 of
adjusted net capital gain. Since their ordinary income
exceeds the 25% income tax threshold, none of their adjusted
net capital gain would be subject to the zero tax rate - all
$5,000 would be subject to the 15% rate.
Planning Tip: To the extent taxpayers have a
gap between (1) their ordinary income plus net capital
gains and dividend income not included in adjusted net
capital gain and (2) their 25% income tax threshold,
that gap can be taken up by adjusted net capital gain
subject to the zero tax rate, even if they have income
that is subject to higher rates.
Example 4. Frank and Susan Taxpayor file a joint return with
adjusted gross income (AGI) of $225,000, consisting of
$105,000 of wages, plus $120,000 of adjusted net capital
gain. For 2008, the Taxpayors claim a total of $55,000 in
personal exemptions and itemized deductions, resulting in
taxable income of $170,000 ($225,000 AGI minus $55,000 in
deductions). The zero rate applies to $15,100 of the
Taxpayors' adjusted net capital gain calculated using the
formula above as follows:
the $65,100 maximum threshold for joint filers for 2008,
minus
their $50,000 of regular taxable income ($170,000 taxable
income minus $120,000 of adjusted net capital gain).
The $104,900 balance of the Taxpayors' adjusted net capital
gain ($120,000 minus $15,100) will be subject to the 15%
rate.
Planning Tip: 2008 year-end tax planning should
pay careful attention to opportunities to use income and
deduction timing to make clients eligible for the zero
tax rate.
Application of the "Kiddie Tax"
Also new for 2008 is that the "kiddie tax" (which applies to
the child at his or her parents' highest marginal rate on
the child's unearned income over $1,800) affects many more
children.
For tax years before 2008, the kiddie tax applied only to
children under 14. Effective January 1, 2008, a child is
subject to the kiddie tax if he or she is (a) under 18; or
(b) age 18, or a full-time student and 19-23 years old, and
his or her earned income constitutes one-half or less of
that child's support.
Planning Tip: If the earned income of a child
age 18, or age 19-23 if a full-time student, exceeds
one-half his or her support, the kiddie tax rules will
not apply and the child will be able to take advantage
of the zero rate for long-term capital gains and
qualified dividends.
Conclusion
The zero tax rate for adjusted net capital gains presents a
significant opportunity for those clients whose ordinary
income is less than their 25% income tax rate threshold (no
matter how high their other income), as well as clients with
college-aged children whose earned income is greater than
one-half of their support. Like so many other areas, this is
one where the client's planning team needs to work together
to ensure that clients pay the least amount of tax possible
while still accomplishing personal goals and objectives.
Paying no tax on eligible adjusted net capital gains can
provide additional investible assets or increased liquidity
to fund the planning team's recommendations.
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