In the United States, the 2001 Economic Growth and Tax Relief Reconciliation Act significantly reduced capital gains tax rates for most individual income taxpayers. Under the act, current tax rates from capital gains may range from a maximum of 35 percent (equivalent to the highest marginal tax rate for ordinary income) to a minimum of zero for certain taxpayers. To qualify for a zero percent tax rate on capital gains, multiple requirements must be met.
A stock's holding period is the length of time between the date the stock was first acquired (whether through purchase, inheritance, exchange, or form of transfer) and the date the taxpayer disposes of her interest in the stock, typically through a sale. Capital gains from the sale of stock are bifurcated into two categories. Those stocks with a holding period of one year or less are considered to generate short-term capital gains or losses, while stocks with a holding period of more than one year are considered to generate long-term capital gains or losses. Only stocks with long-term capital gains or losses can qualify for the special reduced capital gains rates. Short-term capital gains or losses are taxed at ordinary income rates.
To qualify for the reduced long-term capital gains tax rates, taxpayers must first offset any stocks with a realized long-term capital gain against any stocks that have a realized long-term capital loss. The result is the taxpayer's net long-term capital gain. However, before the reduced capital gain rate treatment can be applied to this amount, it must first be offset against any net short-term capital losses, if any. In offsetting losses, the taxpayer must consider any carry-forward losses from the prior year and include those in the offset amount. After all losses have been offset against capital gains, the remaining long-term capital balance then qualifies for the reduced long-term capital gain tax rates.
As of publication, the Internal Revenue Code has two reduced long-term capital gain tax rates, 15 percent and 0 percent. The eligibility for these rates are based on the taxpayer's overall level of taxable income. Taxpayers falling in a 10-percent or 15-percent marginal income tax bracket for ordinary income are eligible for a long-term capital gain rate of 0 percent. Taxpayers with greater levels of taxable income -- those in a 25-percent or greater marginal income tax bracket for ordinary income -- are ineligible for the 0-percent rate and instead qualify for a 15-percent long-term capital gains rate.
To qualify for long-term capital gains treatment, the gains and losses from stocks and other capital assets must be fully realized, meaning the stock has been sold or otherwise disposed of. Complicating this concept is the IRS's wash sale rules. If a taxpayer repurchases or reacquires a stock that has been sold for a taxable loss within 30 days of the original sale, the stock is not deemed to be sold for tax purposes and may not reported as a realized capital transaction for individual income tax purposes.
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