Harper: It pays to think long term for taxes


By Patrick Harper, CPA

So the more money you make, the higher your tax rate, right? Well, not necessarily. When it comes to tax rates, not all income is equal.

One of our customers who invests in real estate asked if there was a tax benefit to holding a property with a gain more than one year versus flipping it right away. The answer is yes and the benefit is substantial. So this week I'll cover the general rules to qualify for the lower long term capital gain tax rates.

In the beginning of taxes, all income was taxed at the same rate. Then in 1921, a lower tax rate was introduced for capital gains, which can be loosely defined as "investment income." The theory is that a lower tax rate on investment income will encourage investment and thereby boost the economy. To qualify for the lower rates, you had to keep the investment for a minimum period of time, generally more than one year.

Until 2000, dividend income was taxed at ordinary income rates. Then the Bush tax cuts lowered the rates to the same as long term capital gains. As the tax cuts were expiring at the end of 2012, many public and private companies declared "special dividends" before year end to lock in the maximum 15 percent tax rate on dividends for their shareholders. As part of the fiscal cliff tax negotiation, the favorable tax rates for dividends were made permanent, so that for 2013 and beyond, "qualified" dividends (most dividends are qualified, but some are not) are taxed at the same rate as long term capital gains.

If your taxable income is $100,000 and you get paid a $10,000 bonus, your income tax on the bonus is $2,500. If instead you make $10,000 from dividends on a stock, the tax on the dividends is only $1,500. Whatever tax bracket you are in, long term capital gain income is taxed at a much lower rate than ordinary income.

Income subject to ordinary income rates: Some examples are wages, interest income and pension distributions

Income subject to long term capital gain rates: Some examples are dividends and capital assets held more than one year (stocks, bonds, real property)

This tax rate benefit is here to stay, so be aware as you consider your investments. If you have a gain on a capital asset, consider holding it more than one year to get a lower tax rate, if you feel comfortable that the value will not decline. And consider converting interest income to dividend income on your short-term holdings, if the risk is comparable.


Upcoming due dates for businesses:

Jan. 31: Issue W-2s and 1099s to employees and independent contractors

Jan. 31: Payroll tax and sales tax returns due


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