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Guide to Tax Law
- Introduction to Tax Law
- What is the IRS?
- Filing Your Tax Return
- Rights of Tax Payers
- Tax Free Income
- What is a Tax Credit?
- Tax Implications of Differed Income
- How Tax Deductions Work
- Tax Benefits for Homeowners
- Shifting Income withing a Household
- Your Status as a Tax Payer
- Small Business Owners and the IRS
- Minimize Taxes on Your Estate
- Tax Fraud and other Crimes
- Red Flag: IRS Audits
- Taking Your Case to Tax Court
- What if Your Owe the IRS?
- When to Hire a Tax Attorney
Investing can reduce your taxes by allowing you to pay a lower tax rate then you otherwise would, provided you have invested the funds for a sufficient period of time.
To have a capital gain or loss, the taxpayer must have a capital asset, must sell or exchange property in that tax year, and the asset must have been held for more than a year (year + one day). The taxpayer must have a "net capital gain" to receive preferential tax rate treatment.
Net Capital Gain = excess of the net long-term capital gain (LTCG) for taxable year over short-term capital loss (STCL) for such a year
Capital Gains Tax
There has always been preference for long term capital gains—i.e. if your income comes in the form of capital gains derived from capital assets that you have held long enough (over a year), then that gain is not taxed at the highest rate under §1(h), but could be taxed as low as 15% (maximum rate for capital gains)
Today, taxpayers have a very real preference for income to qualify as capital gains. For example, if a taxpayer makes one dollar of ordinary income, that income will be taxed .35 cents. Alternatively, if a taxpayer makes one dollar of one dollar of capital gain, it will be taxed .15 cents. Thus, the taxpayer saves .20 cents by utilizing the capital gains tax rate instead of the ordinary income tax rate.
How to Minimize Capital Gains Tax
The US Tax Code has always specially treated capital losses as well as capital gains (even during a period when there was no special treatment of capital gains after 1986).
To minimize capital gains taxes, a taxpayer can realize their losses at anytime by selling property. Alternatively, a taxpayer can avoid realizing their losses by not selling property.
The taxpayer can minimize capital gains taxes by making careful choices about the years they will use losses (i.e. sell) to wipe out high-taxed income.
The taxpayer can also seek lower tax rates for the following:
- Securities options
- Stock of closely held corporations
- Collectibles held as personal investments (i.e. baseball cards, stamps, rare coins, art, etc. In this case, a 28% (not 15%) maximum federal tax rate applies)
- Personal residences (including vacation homes); Vacation time-share interests; Country-club memberships, etc.
The Tax Code makes a limitation to recognize capital losses.: Corporations can only use capital losses to reduce capital gains. Individuals can use capital losses to reduce capital gains, but if you have more losses than gains, you can use some of the capital losses to shelter some of ordinary income.
Minimizing Taxes on Earnings
Dividends
Dividends are considered income under §61. They can used to be taxed at the same rate as income but now, there is a 15% cap. Dividends are heavily regulated because of the potential abuses – such as a corporation disguising income. For example, a corporation could hide income by classifying it as an employee salary (considering shareholders as employees), so that the corporation can avoid the corporate tax by taking a deduction for it.
Mutual Funds
Mutual-Fund Investments that are held for more than a year and sold for a profit are subject to the lower tax rates given to long-term capital gains. As a practical matter, individuals who are in the 25% tax bracket or higher will owe a maximum of 15% of profits to the IRS. Security Exchanges (i.e. Mutual Funds): A taxpayer will be considered to have acquired the property on the "trade date"