Taxpayers who sold some investments this year may be able to employ an oft-overlooked tool to whittle down the taxes owed and qualify for a 0% rate.
There are three income-based tax brackets on long-term capital gains: 0%, 15% and 20%, as well as a 3.8% Medicare surcharge imposed on the wealthiest Americans.
For the 2023 tax season, the 0% rate on long-term capital gains – any asset held for longer than a year – can be applied to taxable income of $41,675 or less for single filers and $83,350 or less for married couples filing jointly.
The income limits are also higher than they appear: That's because the 0% rate is based on an individual's taxable income, which is calculated by subtracting the standard deduction or a total of itemized deductions – whichever is greater – from your adjusted gross income. In 2022, the standard deduction is $12,950 for single filers and $25,900 for joint filers.
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Nominally, that means the rate applies to a minimum of $57,575 for individuals and $109,250 for married couples.
But even for taxpayers that qualify for the rate, there are limitations.
"There’s a lot of confusion about how the 0% rate works," Eric Bronnekant, a certified financial planner and the head of tax at Betterment.com, told FOX Business. "The way I try to start the explanation is that there’s no such thing as an unlimited 0% rate."
One important caveat is the concept of "stacking," he said, in which ordinary income is used as the primary qualifier for the 0% rate.
For instance, if an individual had long-term capital gains and qualified dividends of $20,000 and earned $100,000, they make falsely believe they are eligible for the 0% rate. But because of the "stacking" principle – in which ordinary income is at the bottom and the capi9tal gains are on the top – a $100,000 salary would push that individual into the 15% rate.
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"I would call it a common misconception," Bronnekant said.
On top of that, there is a limit to how much in investment income is tax-free. Even if taxpayers have no taxable income, the 0% rate on long-term capital gains only works up to the income-level threshold.
"A common question I’ve gotten is, ‘If all I have is $1 million in long-term gains and qualified dividends and that’s my only income, can I get the 0% rate?,'" he said. "I’m like yes, but not on $1 million. You’ll get it on a small portion of that amount."
There are also strategies that higher earners can utilize in order to take advantage of the 0% long-term capital gains tax rate, according to Michael Ruger, partner and chief investment officer at Greenbush Financial Group in Albany, New York.
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Taxpayers can play what Ruger referred to as the "income timing game" to optimize the lower rate: If an individual plans to retire soon, they may consider waiting to sell that investment property until after retirement, because they will fall into a lower tax bracket than in their working years.
"When you look at someone who you have some of these higher-net worth individuals, they can basically pick their tax rate," he told FOX Business. "They don't show an income. They're pulling money out of after-tax assets."
