Luminola | E + | Getty Images
It is natural to focus on portfolio losses, especially with Standard & Poor’s 500 down more than 20% on the year.
But you can still make gains after years of growth, and earnings may qualify for a 0% tax rate, depending on your earnings.
The thresholds may be higher than you expect — up to six figures for a married couple’s combined income, say financial experts.
Many investors are considering two rates of long-term capital gains, 15% and 20%, explained Dale Brown, chairman of Salem Investments in Winston-Salem, North Carolina, which ranked No. 6 on CNBC’s 2022 FA 100 list.
But there are actually four rates – 0%, 15%, 20% and 23.8%, with a 3.8% surcharge for higher earners. “I had clients with low, six-figure incomes who didn’t pay any taxes,” Brown said.
Here’s how: The rates use “taxable income,” calculated by subtracting the largest standard or itemized deductions from the adjusted gross income, which is earnings minus the so-called “above the line” deductions.
For 2022, you may qualify for a 0% long-term capital gains rate with taxable income of $41,675 or less for single applicants and $83,350 or less for married couples applying together.
Six-figure workers may qualify for a 0% rate.
While a couple making $100,000 might assume they don’t qualify for the 0% long-term capital gains tranche, Brown said investors need to tackle the numbers.
For example, let’s say a retired couple has $30,000 in tax-deductible interest, $25,000 in ordinary income and $75,000 in capital gains and long-term earnings. Their gross income is $100,000 because it does not include tax-deductible interest.
After subtracting the standard deduction of $27,000, they have $73,000 of taxable income left, and fall within the 0% long-term capital gains tax bracket for 2022.
A portion of your earnings may be in the 0% category.
Brown said that even if a couple’s taxable income was above $83,350, a portion of their earnings could still fall into the 0% bracket of long-term capital gains.
Suppose the same retired couple had $30,000 in tax-free interest, $25,000 in ordinary income and $100,000 in long-term capital gains and dividends.
In this case, their total income is $125,000 and taxable income is $98,000. Since the standard deduction of $27,000 exceeds $25,000 of ordinary income, the $98,000 is all capital gains and long-term earnings.
This means that $83,350 is taxed at 0% and the spouses owe 15% long-term capital gains taxes on the remaining $14,650.
“That’s the 0% segment benefit,” Brown said.
Consider “Tax Gain Harvest” in the 0% Segment
When the stock market goes down, many investors focus on harvesting the tax loss, or using the losses to offset other profits.
You can also explore harvest gains if your assets are still higher than in previous years, said Cory Robinson, vice president and portfolio manager at Tom Johnson Investment Management in Oklahoma City, which ranked first. 30 on the FA 100 list.
“The interest is zero tax, whether it’s dividends or capital gains,” he said, as long as you’re below the taxable income threshold.
This is the beauty of reaping profits. You can reinvest immediately.
Corey Robinson
Vice President and Portfolio Manager at Tom Johnson Investment Management
For investors in the 0% category, it is possible that there is an opportunity to lower taxes on future earnings.
Because taxes are based on the difference between the value at sale and the original purchase price, you can sell the profitable asset and buy back to increase the purchase price.
“That’s the beauty of cashing in: you can reinvest right away,” Robinson said, explaining how investors don’t need to worry about the so-called wash sell rule.
Although the wash sell rule prevents realized losses if you buy a “substantially identical” asset within the 30-day period before or after the sale, the same rule does not apply to gains, he said.
Reap the gains during the low income years
Whether you’re selling assets for income or taking advantage of a long-term tax strategy, Brown said, there may be opportunities to reap gains during low-income years.
For example, there may be an income gap if you retire but don’t immediately get Social Security, a pension, or withdrawals from pre-tax retirement accounts.
You may also have lower taxable income in a year with a temporary job loss, Brown said.
“The most important thing is timing,” Robinson added, explaining how important it is to estimate taxable income before trying to reap the gains.