The stock market's rebound from its nadir in March 2009 means
many investors are back in the money. And some them will owe no tax
on the profits they cashed in last year when they file their 2010
tax return this spring.
Normally, capital gains and qualified dividends are taxed at a
maximum rate of 15% -- a bargain compared with the top income tax
rate of 35%. But for 2010 (and through 2012), investors in the two
lowest income tax brackets will pay no tax on their capital gains
To qualify for preferential capital-gains treatment, you must
hold shares of your stocks or mutual funds for more than a year
before selling. (This applies to assets in taxable accounts, but
not those in retirement accounts. Profits inside a tax shelter are
not taxed when the gains are realized, but are taxed at your
ordinary rates upon withdrawal.) Short-term capital gains on assets
held less than a year are taxed at a maximum 35%.
To figure your tax liability on your investments, you must first
match any short-term gains with short-term losses and long-term
gains with long-term losses. If, after netting capital gains and
losses, you are left with a capital gain, it is taxed at a maximum
15% -- or, depending on your tax bracket, 0%.
But if you are left with a loss, you can use it to offset up to
$3,000 of ordinary income, such as wages, and carry forward excess
losses to future years. The key is that the loss must be real, not
just a paper loss, in a taxable account. Losses in a retirement
account, such as an IRA or 401(k), generally can't be used to
reduce ordinary income.
To take advantage of the 0% capital-gains rate for 2010, your
taxable income can't exceed $34,000 if you are single; $45,500 if
you are a single head of household with dependents; or $68,000 if
you are married filing jointly. Note that this is taxable income.
That's what's left after you subtract personal exemptions -- worth
$3,650 each in 2010 for you, your spouse and your dependents -- and
your itemized deductions or standard deduction from your adjusted
The standard deduction for 2010 is $5,700 for individuals;
$8,400 for heads of households; and $11,400 for married couples.
Plus, there's an added standard deduction of $1,100 per person for
married individuals 65 or older and $1,400 for single filers 65 or
Any gains that lift your income above that threshold would be
taxed at the maximum 15% capital-gains rate.
Likely candidates to benefit from the 0% tax rate include
retirees, who have a higher standard deduction than younger
taxpayers and who are not taxed on some of their Social Security
benefits, and the unemployed, who may have had to tap their
investments to make ends meet.
One group of taxpayers who won't benefit from the zero
capital-gains rate are children affected by the "kiddie tax."
Dependent children under 19 and full-time students under 24 are
affected by the special rule that applies their parent's higher tax
rate to investment income they received in 2010 in excess of
Advice for fund investors
If, like most investors, your mutual fund dividends are
automatically used to buy extra shares, remember that each
reinvestment increases your tax basis in the fund. That, in turn,
reduces the taxable capital gain (or increases the tax-saving loss)
when you redeem shares. Forgetting to include the reinvested
dividends in your basis results in double taxation of the dividends
-- once when you receive them and later when they're included in
the proceeds of the sale. Don't make that costly mistake. If you're
not sure what your basis is, ask the fund for help.