Can Capital Gains on Stocks Be Prorated in Two Different Tax Brackets?

by Michael Dreiser

In the United States, the Internal Revenue Code allows for capital gains from the sale of stock to be bifurcated into two tax rates based on the underlying holding period of the stock. In addition, certain short term capital gains from the sale of stock may be split amongst multiple tax brackets based upon the taxpayer's other net taxable income.

Overview

In order to encourage individual income taxpayers to both devote money towards savings and to invest in corporations -- which has a positive economic impact -- the Internal Revenue Code provides for special, reduced income tax rates for taxpayers who realize taxable income from the long-term holding of stock. Income subject to these special, reduced income tax rates comes in two forms: Dividends, the periodic cash disbursements to shareholders, and capital gains, the gains from the appreciation in the value of shares of stock. Capital gains are only subject to taxation when they become realized from the sale of the stock. Unrealized gains are not taxable.

Holding Period and Rates

All capital gains must be bifurcated based on the holding period of the asset. Stocks that have been owned by the taxpayer for a year or less are considered to be short-term capital assets. Conversely, stocks that have been owned for more than a year are considered to be long-term capital assets. The special, reduced income tax rates are only available to long-term capital assets. The long-term capital gains rate depends on the taxpayer's marginal income tax rate on all sources of income. For taxpayers in a marginal income tax bracket of greater than 25 percent, the long term capital gains rate is 15 percent. For all other taxpayers in a marginal income tax bracket of less than 25 percent, the long term capital gains rate is zero.

Short-Term Capital Gains

Unlike long-term capital gains, gains from the sale of stock with a holding period of a year or less are not eligible for any special taxation rates. Short-term capital gains are taxed at full, ordinary income tax rates. This means that the tax rate paid on short-term capital gains may be prorated over multiple tax brackets. If, for example, a taxpayer in a 25-percent federal income tax bracket recognizes sufficient income from short-term capital gains to push the taxpayer into the next federal income tax bracket (the 28-percent bracket), then the short term capital gains are taxed at a 25-percent rate until the bracket ceiling is reached, and then at a 28-percent rate.

Reporting

Capital gains from the sale of stock are reported to the IRS using Schedule D, Capital Gains and Losses and U.S. Form 1040, U.S. Individual Income Tax Return. Taxpayers are required to provide the IRS with a description of the asset sold (such as "100 shares of ABC Corp."), to list the date the stock was acquired, the date the stock was sold, the gross proceeds and the stock's cost or other basis. Taxpayers also must compute the gain or loss. In addition, taxpayers use the form to bifurcate between long term and short term assets and to compute the net long-term capital gain or loss and the net short-term capital gain or loss.

About the Author

Michael Dreiser started writing professionally in 2010. He is a certified public accountant with experience working for a large New York City accountancy and expertise in areas ranging from private equity taxation to investment management. He holds a Master of Business Administration in international finance from l’École Nationale des Ponts et Chaussées in Paris.