Why Investment Income Is Preferable to Ordinary Income from a Tax Standpoint

Corporations and individuals alike are required to pay federal income tax on all of their capital gains earnings, with the rate of taxation depending on their tax bracket and how long they held the investment before selling it.

Capital gains come into effect when you sell a stock or other capital asset for more than its original purchase price, or basis. Conversely, if it is sold for less than its basis, the result is a capital loss. Capital gains are tax-preferred, meaning that they may be taxed at lower rates than wages, interest, and other forms of income. There are two types of gains: short-term and long-term.

Short-Term

Short-term net capital gains, which are defined as investments retained for less than a year before being sold, are taxed at the regular income tax rate of the taxpayer. 2015 federal income tax rates for individuals is anywhere from 10% for single people with taxable income of $9,225 or less to 39.6% for higher earners making upwards of $400,000. Corporations are taxed at rates of 15-35%.

Long-Term

Long-term net capital gains are gains realized after selling an asset held for one year or longer. The tax rate on most net capital gains is 15% for most taxpayers. Some or all net capital gains may be taxed at 0% for taxpayers in the 10% or 15% regular income tax brackets. However, a 20% rate on net capital gains applies to taxpayers in the 39.6% regular tax bracket (i.e., single taxpayers with taxable income over $406,750 or married taxpayers with taxable income over $457,600, etc.).

Because capital gains do not become taxable events until the asset is sold and you realize the gain, you can control how much tax you owe by timing the date of the sale. This is an advantage that does not apply to regular income. You can also use up to $3000 in capital losses to offset other income, thereby reducing the amount of income tax that you owe. Any loss over that threshold can be carried over into later years.

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Written by Desnoyers CPA

Desnoyers CPA

Known for her friendly, outgoing nature and her rare talent for financial foresight, Lydia Desnoyers has been serving individuals and small businesses in Florida since 2010. After earning her Master’s Degree in Accounting from Nova Southeastern University and her Bachelor’s Degree in Accounting from Florida State University, she became a Certified Public Accountant and a Certified Fraud Examiner.