Post-Election Tax Situations: Increase in Capital Gains and Dividends Tax Rates

Under current law, the reduced tax on long-term capital gains and qualified dividends are scheduled to revert in 2013 to their pre-2003 rates. For the past ten years, taxpayers in the 10% or 15% tax bracket did not have to pay federal income tax on long-term capital gains. Individuals in higher tax brackets incurred 15% tax on long-term capital gains. Additionally, qualified dividends have been taxed at the reduced capital gains rates.

President Obama campaigned on allowing the Bush-era tax cuts – including the reduced capital gains and dividends tax rates – to expire for higher income individuals, and he is not expected to change his position now. Under the President’s proposal, the current zero and 15 percent capital gains and dividend tax rates would be extended after 2012 for single individuals with incomes below $200,000 and families with incomes below $250,000. For individuals with income over $200,000 and families with incomes over $250,000, the President proposes increasing tax rates on qualified capital gains to 20 percent and qualified dividends to be taxed at ordinary income rates.

For dividends, the increase in tax rates for higher-income taxpayers represents almost a 300 percent increase when a top 39.6 percent rate is combined with the new 3.8 percent Medicare contributions tax on net investment income. The capital gains rate would jump from 15 percent to 20 percent (or 23.8 percent with the 3.8 percent Medicare tax).

Investment decisions should not be made solely for tax purposes. However, if a taxpayer is expecting to incur large capital gains or make substantial sales, they may want to consider completing the transactions in 2012 rather than waiting until 2013. The higher rates on capital gains and dividends would increase marginal tax rates on portfolio income for high-income taxpayers. Qualified corporations may want to consider declaring a special dividend to shareholders by December 31, 2012 to take advantage of more favorable tax rates.

Due to the 2013 tax laws still in limbo, we will be following the progress in Congress. In the meantime, please contact your Anders tax advisor for any questions related to the potential changes in tax policies. Also be sure to check back tomorrow for our post on the change in educational credits and deductions.