How US federal long term capital gains taxes are calculated
This is the text transcript of this video. It also includes the slides used in the video above.
This is the first part of this two-part video series on long-term capital gains taxes.
I’m Larry Russell. Today we’re going to go over long-term capital gains taxes and discuss actually how they’re calculated. This is this is the first of two videos I intend to do. This is an overview.
So let’s go to the first graphic that shows us actually what the tax brackets are and what the tax rates are. First I will point out that this is for married taxpayers filing jointly. On the next slide I’ll show you what it is for single taxpayers. These are the two main categories of filing for income taxes.
This example assumes that there is no other ordinary income on a tax return. What that means is you don’t have any kind of bonuses salary or other other taxes like that. The only thing you have to report is capital gains taxes.
Now, the first thing to note here is that a long-term capital gain, which is this LTCG abbreviation, is a capital asset that one owns and is held for at least one year. The zero-percent LTCG tax rate applies from zero dollars up to $75,300. Then, from $75,300 for married taxpayers up until $466,950, the tax rate is fifteen percent. Then, above this level the tax rate goes to twenty percent.
Now, this is more advantageous than ordinary income tax rates. One thing you begin to see right here is the seventy five thousand three hundred dollar breakpoint here actually turns out to be the break point between the ordinary income tax rate of fifteen percent in twenty-five percent. Note that the tax rate numbers were using here for 2016.
A couple other things to note about break points is that they are inflation indexed, and the dollar break points will change from year to year but the concept behind this is stable. In addition to that, note that state income taxes might apply in some states. If indeed you have long-term capital gains at the state level, you’re going to end up paying ordinary income tax rates at the state level.
Other things that are actually quite important are ordinary income We are going to see in examples coming up that ordinary income is net of deductions and exemptions. So, therefore, the higher your deductions and the more exemptions you have, the less ordinary taxable income you will have.
Now we jump to single taxpayers. The zero-percent long-term capital gains tax bracket for a single taxpayer is from $0 up to $37,650 for tax year 2016. Again, this is equal to the break point for single taxpayers from fifteen to twenty five percent for ordinary incolme taxes. If you recall this breakpoint is $75,300 for married taxpayers filing jointly, so the single taxpayer breakpoint is half as much as the break point for married filing jointly. Up here you notice that the fifteen percent LTCG tax rate to 20% break point is at $415,050.
Now here is the thing that confuses a lot of people. While we have advantageous long-term capital gains tax rates, there is a link between the long term capital gains tax regime and that of ordinary income taxes. In the previous two slides, I gave the example of the situation where there was no ordinary income.
In this case, we’re looking at fifty thousand dollars worth of ordinary income, and that IS something like wages and salaries. This ordinary taxable income will be taken into account first when assessing long term capital gains tax rates. If you look at this blue line here, the ordinary income kind of acts like a plunger to push up on the taxation rates on your your long-term capital gains.
In this case we start out with $50,000 ordinary income, and then we add $100,000 of taxable long-term capital gains on top of that. The way the actual tax rates work is that if you had $50,000 worth of taxable ordinary income, it will consume some of this 0% tax LTCG bracket.
So if you look up here at these, numbers right here this is the first break point of $75,300 minus $50,000 of ordinary income leaves a remainder $25,300. This means that $25,300 of this $100,000 taxable long-term capital gain will be taxed at zero percent. The remainder of that long-term capital gain will be taxed at fifteen percent.
The way you run the math is you take a $100,000 minus the amount of the long-term capital gain that has been taxed at 0%. So $100,000 minus $25,300 leaves $74,700. This remaining $74,700 will get taxed at fifteen percent. So, the net total tax on this $100,000 long-term capital gain in this particular situation is $11,205. And, if you just take a look at the overall LTCG tax rate on $100,000, that’s about an 11.2% average tax rate.
Now, if we move on to the single taxpayer for this particular situation, we see that it’s a little bit different. The reason it is a little bit different is because since this person already has $50,000 worth of regular ordinary income, this pushes this single person’s initial long term capital gains rate above the first break point. This means that this $100,000 starts at $50,000, and therefore all of this long-term capital gain is going to be taxed at 15%, And, again we are nowhere near the upper break point that would push this person into the 20% tax bracket on long term capital gains for a single tax payer.
You look at this, and you say ok $50,000 in taxable ordinary income will displace the full 0% long-term capital gains tax rate range. Therefore, all of the $100,000 taxable capital gain will be taxed at 15%, Therefore, the long term capital gains taxes are $15,000 and this is a 15-percent average tax rate.
To conclude, regarding long-term capital gains, first to be a taxable long term capital gain, you have to have held the asset for one year. Long-term capital gains tax rates are substantially lower than ordinary income tax rates, and the LTCG breakpoints are linked to the graduated ordinary income tax rates. They are also inflation-adjusted.
The key point is the linkage between the two tax systems. Ordinary taxable income will push your tax rate on long-term capital gains up into higher LTCG tax brackets. Even then the resulting long-term capital gains tax bracket obviously are lower than ordinary income tax rates.
Again, state taxes are in addition and both ordinary income and long-term capital gains would be taxed at ordinary income tax rates for your state. Lower long term capital gains tax brackets are a federal tax code topic.
As a little bit of a commentary, this is kind of ridiculous. These calculations are excessively complex, but at least now you know how they are calculated.
In the next video that I will do on the subject of US federal long-term capital gains taxation, I will take a specific example. Then, I will work through the various tax forms, so you can actually see how long term capital gains taxes are implemented on the tax forms.
Thank you very much for listening.
