Can Capital Gains Push You Into a Higher Tax Bracket?
About taxes, Albert Einstein once said, “This is too difficult for a mathematician. It takes a philosopher.”
While taxes aren’t always clear-cut and can often be complex, understanding how they work can save you a lot of money and headaches. This is especially true when it comes to capital gains taxes.
Can capital gains push you into a higher tax bracket? Here, we explain.
What Are Capital Gains?
Let’s say you have a significant asset you want to sell: like a parcel of real estate, valuable gemstones, precious metals, or stocks and bonds. Your goal would be to sell that property for as much as possible–perhaps even more than you paid for it. These are known, in the tax world, as “capital assets.”
When you’re able to sell anything included in this category for more than its original purchase price, the money you earn as a result is called a “capital gain.”
How Capital Gains Affect Taxes
Profits from capital gains are a type of income and are considered taxable. Some capital gains and qualified dividends are taxed at a separate (and lower) rate compared to the income tax rate.
In total, there are seven federal income tax brackets for the 2021 tax year. Assuming you’re married and filing jointly, these range from 10% (if you made $19,900 or less) to 37% (if you made $628,301 or more).
For taxpayers who are married and filing jointly, capital gains are taxed at 0% (if they’re no more than $80,800), 15% (if they’re between $80,801 and $501,600), or 20% (if they reach or exceed $501,601). Furthermore, if your capital gains exceed these thresholds, everything that fits into the lower groups will be taxed at that rate. The remainder will be taxed at a higher rate.
With that said, these tax rates change based upon total income (earned income + investment income). Therefore if someone makes $450k in salary and has $75k in capital gains, their capital gains tax rate will be 20%.
Short Term vs. Long Term Capital Gains
Most capital gains are taxed at lower rates than “ordinary” income depending on how long the asset was owned.
Short Term Capital Gains Tax Rate
Short-term capital gains are just capital gains resulting from the sale of assets you’ve owned for a year or less. But while a quick turnaround on investments can be desirable in some cases, it won’t be much help to you when tax season arrives.
Short-term capital gains are taxed at your highest income tax bracket, based on your income, no matter what income bracket you fit into. Here’s the complete list of 2021 tax rates on short term capital gains and other types of income (for married taxpayers filing jointly):
Income up to $19,900- 10%
Income between $19,901 and $81,050- 12%
Income between $81,051 and $172,750- 22%
Income between $172,751 and $329,850- 24%
Income between $329,851 and $418,850- 32%
Income between $418,851 and $628,300- 35%
Income above $628,300- 37%
Long Term Capital Gains Tax Rate
Long-term capital gains apply to a property you’ve owned for more than a year. Unlike short-term capital gains, long-term capital gains qualify for the previously-explained capital gains tax brackets helping you save on taxes as a result.
Collectibles
Aside from short-term and long-term capital gains, another tax rate applies to capital gains from selling certain collectibles. This flat rate of 28% applies to capital gains from these items, among others:
Antiques
Art
Coins
Jewelry
Precious metals
Stamp collections
Cryptocurrency
It’s no secret that cryptocurrency is of the most buzzed-about topics in the world of finance today, so you may be wondering how these currencies are taxed. If you get the concept of capital gains, you’re well on your way to factoring Bitcoin and similar assets into your taxes.
As of 2021, the US tax rates for cryptocurrency are identical to the overall rates for capital gains. That means short-term crypto gains will be taxed at a rate between 10% and 37%, while long-term gains will be taxed at rates between 0% and 20%. Meanwhile, gains from selling cryptocurrencies are calculated based on the holding period before you sold these assets and your overall income.
While this isn’t everything you need to know about crypto and taxes, it should give you a solid start.
Will You Be in a Higher Tax Bracket?
The answer is a resounding “it depends.”
Long-term capital gains are calculated after the rest of your income and have different tax rates, meaning these capital gains will not push you into a higher income tax bracket. Short-term capital gains, however, are considered “regular” income. With that in mind, you should be careful when selling assets you’ve owned for a year or less–especially if it could net you a significant profit.
To demonstrate these concepts, let’s say you and your spouse made exactly $329,850 in combined income this year, just barely allowing you to qualify for the 24% income tax bracket. On top of this, you managed to realize another $100,000 in long-term capital gains and $1 in short-term capital gains.
The $100,000 from long-term capital gains wouldn’t push you into the 32% tax bracket, but the dollar you made from short-term capital gains would–the higher tax rate is only on the NEXT dollar, so the $1 that pushes you into the 32% bracket would be taxed at 32%.
Income brackets aren’t the only thing you should consider when thinking about capital gains and taxes, either. Regardless of their category, capital gains can add to your modified adjusted gross income (MAGI), potentially locking you out of the ability to contribute to an IRA or Roth IRA. You also run the risk of getting phased out of certain tax credits and itemized deductions.
Net Investment Income Tax
If you’re filing jointly and your MAGI is over $250,000 ($200,000 if filing single), you’ll have to pay an extra 3.8% in net investment income tax (NIIT).
Long-term capital gains are taxed at a lower rate than other income sources, but they still get included in your MAGI. That means both types of capital gains are subject to this tax if your income is high enough to trigger it. Even if you otherwise have a low taxable income, exceptionally high capital gains could push you into paying this tax.
Considerations of Capital Gains
Capital gains–especially long-term capital gains–come with many potential advantages. Namely, you can make extra money while enjoying a low tax rate. Of course, whenever you’re making major financial decisions, it’s a good idea to be aware of the potential effects these choices could have on your portfolio and overall.
The best way to reap the benefits of capital gains while keeping your risks to a minimum is to find a reliable guide. When you choose Consilio Wealth Advisors to fill this role, you won’t just get great financial advice, you’ll be able to understand it without a dictionary.
Instead of relying on the unqualified opinions of anonymous internet users or an advisor who uses industry jargon to push you in different directions, trust experienced experts who use their knowledge to help you make the best decisions for your financial future.
Disclosures
The information provided in this article is for educational and informational purposes only and does not constitute investment advice and should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor's particular investment objectives, strategies, tax status, or investment horizon. You should consult your attorney or tax advisor.
The views expressed in this commentary are subject to change based on market and other conditions. These documents may contain certain statements that may be deemed forward‐looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur.
Consilio Wealth Advisors, LLC ("CWA") is a registered investment advisor. Advisory services are only offered to clients or prospective clients where CWA and its representatives are properly licensed or exempt from licensure.
