The Internal Revenue Code bifurcates capital gains income into two categories: short-term (<1 year holding period) and long-term (>1 year holding period). The Code gives preferential tax treatment to long-term gains but taxes short-term gains at ordinary income levels. The rationale for the IRS preferring long-term holding periods? The longer a taxpayer holds a security the more likely inflation has unfairly cut into the associated gain. In other words, long-term capital gains income, dollar for dollar, has less purchasing power than it if had been liquidated earlier.
Capital gains rates for 2013 are as follows:
Short-term capital gains:
-Taxed at the taxpayer’s ordinary income tax rates for the current year (ranging from 10% to 39.6%)
Long-term capital gains:
-Individual Taxpayers earning less than $36,250 and Married Taxpayers filing Jointly earning less than $72,500: 0% rate
-Individual Taxpayers earning between $36,250 and $400,000 and Married Taxpayers filing Jointly earning between $72,500 and $450,000: 15% rate
-Individual Taxpayers earning more than $400,000 and Married Taxpayers filing Jointly earning more than $450,000: 20% rate
Suppose Joe, a wealthy individual taxpayer earning $1,000,000 in 2013, purchased 100 shares of ABC stock on 1/1/2010 at $10.00/share ($1,000 total purchase price). On 2/1/2013, with ABC stock trading at $13.00/share, Joe decided to sell all 100 of his shares ($1,300 total selling price). Joe, having held the stock for three years, realizes $300 in long-term capital gains income. Accordingly, he will pay a 20% tax on that $300 gain (owes $60 in capital gains tax). Suppose, for example, the above facts are the same except Joe’s 2013 income is $200,000. Joe would then qualify for the 15% rate and owe $45 in capital gains taxes on his $300 gain.
Photo by: David Paul Ohmer