Stock investors have been highly successful over the past decade. Even in early 2020 the coronavirus bear market did not close the market for long.
The only downside to having large gains in shares is that you often have to share them with the IRS at tax time. But millions of taxpayers do not realize that there is a provision in the tax laws that allows you to sell stocks at a profit without paying any income tax. Below, we will explain how you can find out if you qualify for this strategy and what you need to do to use it.
Think long term to get the IRS off your back
Taxpayers with a long-term investment mindset have long received rewards from the IRS. Traditionally, there is a difference between the treatment of profit on short-term investment versus long-term investment holdings.
In particular, under current law, taxpayers are exempt from tax if they have lived on stocks or other investments for more than a year. Before you sell a stock for a long time, and you will pay whatever your simple income tax rate is on any profits from the sale. Sell after, and you will get a lower rate of tax.
The long-term capital gains tax rate is low for everyone. Those in the current top tax bracket of 37% will have to pay 20% on their long-term capital gains. Those in brackets 24% to 35% receive a similar tax rate on long-term stock profits of only 15%.
But those in the lowest two tax brackets get the biggest break. Thanks to current tax laws, these individuals do not have to pay any tax on their long-term capital gains.
Tax free stock profits
Tax laws include a 0% tax bracket on long-term capital gains up to a certain amount of total income. If you are single and all your taxable income is $ 40,000 or less in 2020, you will not have to pay any tax on your long-term capital gains. For joint filers, that amount is $ 80,000. Those who qualify for the head of household status can have up to $ 53,600 in taxable income before they have to pay any tax on their long-term capital gains.
A large number of Americans are included in that category. According to the latest figures from the Census Bureau, about 19 million households made less than $ 40,000 in total income. More than half the families – 42 million – had a total income of less than $ 80,000.
Also, keep in mind that the break applies to taxable income. This number is less than the total income because taxpayers typically receive either a standard deduction or an itemized deduction that reduces their taxable income.
Either use it or lose it
However, one thing to keep in mind: Your taxable income will include your profits from stock sales. Therefore, if you have so much in long-term capital gains that it seems to exceed the income limit, you will pay some tax on the excess. Then, however, the rate you pay will be lower than the corresponding rate on ordinary income. It takes some of the sting.
2020 will be a highly popular year for this strategy. Many people have temporarily low incomes due to coronovirus-related layoffs and work. This would put them in a lower income tax bracket that could allow them to fall into the 0% long term capital gains tax range.
To use the strategy, you only have to sell the stock at a profit. If you want, you can buy it back immediately in hopes of seeing even more profit. Unlike tax loss, there is no rule that waits for you to claim benefits – even tax-free.
As you consider tax planning at the end of your year, you will want to see if you can redeem stock profits tax-free. If you can, it can save you money by avoiding higher taxes down the road.