Now that we’re rapidly marching through 2008, we want to alert you to this chance for tax free income. Although this opportunity is scheduled to be around beyond this year, it’s hard to predict what may happen after this fall’s elections. Thus, while the availability of the 0% tax rate seems all but certain to remain unchanged for 2008, after that, there are no guarantees.
June 2008
To Our Clients and Friends:
Sometimes our elected officials like to provide deferred gifts. Back in 2003, Congress passed and the President signed into law a provision that provides a zero percent tax rate for certain types of income received by eligible taxpayers. Because the provision wasn’t effective until 2008, it didn’t receive a lot of attention at the time beyond the ranks of professional tax advisors. However, now that we’re rapidly marching through 2008, we want to alert you to this chance for tax free income. Although this opportunity is scheduled to be around beyond this year, it’s hard to predict what may happen after this fall’s elections. Thus, while the availability of the 0% tax rate seems all but certain to remain unchanged for 2008, after that, there are no guarantees.
How Do You Qualify for the Favorable Rate?
You need to have the right type of income. The 0% rate applies to most long-term capital gains (i.e., gain from selling something such as stock that you’ve held for more than a year) and qualified dividend income (generally dividends from U.S. corporations and certain eligible foreign corporations).
You also need to have the right amount of qualified income and the right mix of other income and deductions to maximize the savings from the 0% rate. Depending on your filing status, the 0% rate can apply to up to $65,100 of income this year. However, it could also apply to none of your income (even if you have long-term capital gains and/or qualified dividend income), if your other income and deductions don’t net to a small enough number. As a result, qualifying for the favorable 0% rate is very fact specific.
Double Benefit from Deductions
If a taxpayer has an adjusted capital gain (after considering other ordinary income) that is partially taxed at the 0% rate, any deduction that decreases ordinary income will also simultaneously decrease the tax rate on a comparable amount of adjusted capital gain from 15% to 0%. This has the effect of producing a double benefit for that deduction. On the other hand, adding additional ordinary income would cause a double tax impact, as additional ordinary income would push a portion of the capital gains formerly at 0% upward into the 15% bracket.
Most Dependents Won’t Benefit
When the 0% tax rate was originally enacted, college aged kids (who perhaps received a gift of appreciated stock from their parents to sell and help pay for college) were expected to be prime beneficiaries of the favorable rate. However, because of a recent change in the so called kiddie tax (a provision that generally taxes dependents’ investment income at their parents’ tax rate), individuals through age 23 are now much less likely to benefit from the 0% rate unless they’re either not a full-time student or a full-time student whose earned income for the year is greater than half the cost of their support.
Conclusion
Because qualifying for the 0% rate is so fact specific, low-income taxpayers (such as an older child who is no longer a student or who is beyond age 23 or a parent that you’re helping support) as well as certain very high-income taxpayers who have mostly capital gain or qualified dividend income and little in the way of other taxable income can all potentially qualify. The key is to understand the rules and the options, if any, that are available to improve the chances of qualifying. We’d be glad to help you accomplish this if you would give us a call at your convenience.
Best regards,
Mark R. Sunderland