Tax Law and Business Organization Strategy

Zero Tax Rate on Long-Term Capital Gain and Dividend Income

Beginning this year and continuing through at least 2010, a zero tax rate applies to most long-term capital gain and dividend income that would otherwise be taxed at the regular 15% rate and/or the regular 10% rate. The amount of income taxed at 0% depends on the interplay between an individual's filing status, his taxable income, and how much of that taxable income consists of long-term capital gain and dividends.

The zero tax rate is available only for a noncorporate taxpayer who has a net capital gain and/or qualified dividend income. The zero tax rate doesn't apply to collectibles gain or Code Sec. 1202 gain (gain taxed on sales of certain small business stock), both taxed at a maximum rate of 28%, or to unrecaptured Code Sec. 1250 gain, which is taxed at a maximum rate of 25%.

For tax years beginning after 2007, a 0% tax applies to so much of the adjusted net capital gain (net capital gain reduced by collectibles gain, Code Sec. 1202 gain, or unrecaptured Code Sec. 1250 gain, and increased by qualified dividend income)—or, if less, taxable income—that doesn't exceed the excess (if any) of:

  • the amount of taxable income that would be taxed at a rate below 25% (without taking the special capital gains rates into account), over
  • taxable income reduced by the adjusted net capital gain.

The balance of the taxpayer's adjusted net capital gain is taxed at 15%.

Interpreting the statutory mumbo-jumbo leads to a simplified formula for the amount of a taxpayer's adjusted net capital gain that will be taxed at 0%:

  • the break-point amount, minus
  • regular taxable income

For 2008, the break point is $32,550 for single filers, $65,100 for joint filers, or $43,650 for heads of household. "Regular taxable income" is taxable income reduced by adjusted net capital gain.

For example, assume a married couple whose taxable income of $65,100 for 2008 consists entirely of qualified dividends. The break-point amount for joint filers is $65,100, and couple has no regular taxable income, so the 0% tax rate applies to all of their taxable income.

Or assume a married couple with taxable income of $65,000 in 2008, $55,000 of which is ordinary income and $10,000 of which is adjusted net capital gain consisting of long-term capital gain on the sale of stocks and qualified dividend income. The break-point amount for joint filers is $65,100, and the couple's regular taxable income is $55,000, so the 0% tax rate would apply for up to $10,100 of adjusted net capital gain ($65,100 − $55,000). Because their adjusted net capital gain of $10,000 is less $10,100, all of it qualifies for the 0% tax rate.

Keep in mind, however, most children who are subject to the kiddie tax won't benefit from the 0% tax rate if their parents are in the higher brackets. For 2008, a child subject to the kiddie tax pays tax at his or her parents' highest marginal rate on the child's unearned income over $1,800 if that tax is higher than the tax the child would otherwise pay on it. Beginning this year, a child is subject to the kiddie tax if

  • he or she has not attained age 18 before the close of the tax year; or
  • is age 18, or is a full time student over age 18 but under age 24, and his or her earned income doesn't exceed one-half of the amount of their support.

The stricter rules were designed to discourage families from gifting appreciated stock, mutual-fund shares, and other securities to their low-income, young-adult children who (if no longer subject to the kiddie tax rules and if in one of the two lowest tax brackets) could then sell the securities tax-free under the 0% tax rate rule. The stricter kiddie tax rules eliminate the opportunity to do this in many cases. However, if the earned income of a child over age 18, or age 19-23 if a full-time student, exceeds one-half his or her support, the kiddie tax rules won't apply and he or she will be able to take advantage of the 0% rate for long term capital gains and qualified dividends.

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Comments (2) Read through and enter the discussion with the form at the end
Jake - October 28, 2008 11:14 PM

What is the definition of a noncorporate taxpayer? If I'm an individual and I own a C corporation that distributes a dividend to me would that dividend be subject to the zero tax rate, if my salary is less than $32K?

Jack Howell - October 29, 2008 10:25 AM

Jake: An individual would be a noncorporate taxpayer. If your total regular taxable income (which includes the sum of your salary and capital gains and other income) is less than your threshold amount, then the zero tax rate should apply to you. Jack

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