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Under the current rules, the 2022 federal income tax rates on long-term capital gains are 0%, 15%, and 20% for most categories of long-term gain. As mentioned earlier, the maximum 20% rate affects singles with 2022 taxable income (including long-term gains) above $459,750, married joint-filing couples with income above $517,200, heads of households with income above $488,500, and married individuals who file separate returns with income above $258,600. Higher-income individuals also may be hit with the 3.8% NIIT, which can result in an effective marginal federal rate of up to 23.8% (20% + 3.8%) on long-term gains. Under President Biden’s proposed tax plan, the rate on long-term gains would increase to 39.6% for taxpayers making over $1 million, which, when combined with the NIIT, would result in a marginal rate on long-term gains of up to 43.4% (39.6% + 3.8%).
Until we know exactly where the capital gains rates will fall in 2023, the best strategy at the moment is to be prepared. If rates increase, as the President’s plan indicates, it might make sense to sell winners before year end and hold on to losers until January. At this point, it’s just too early to make any decisions. However, we should be mindful of what’s coming and have a plan in place to time your transactions to result in the best possible outcome.
As you evaluate investments held in your taxable brokerage accounts, be mindful of your holding period. For most taxpayers, the federal income tax rate on long-term capital gains (gains on assets held for over a year) is still much lower than the rate on short-term gains. This will remain true in many cases even if the long-term capital gains rates increase in 2023. Under the proposed plan, only taxpayers making over $1 million will be affected. Therefore, it often makes sense to hold appreciated securities for at least a year and a day before selling to qualify for the lower long-term capital gains tax rate.
Biting the bullet and selling some loser securities (currently worth less than you paid for them) before year end also can be a tax-smart idea. Again, we need to wait and see what the capital gains rates will be in 2023. Any capital losses taken before year end will offset capital gains from other sales this year, including high-taxed short-term gains from securities owned for one year or less. Under the current rules, the maximum rate on short-term gains is 37%, and the 3.8% NIIT may apply too, which can result in an effective marginal rate on short-term gains of up to 40.8% (37% + 3.8%). Future tax legislation could increase the maximum rate on short-term gains, but it could still be significantly higher than the rate on long-term gains for taxpayers making less than $1 million. Whatever happens, you won’t have to worry about paying a high rate on short-term gains if they can be sheltered with capital losses.
If capital losses for this year exceed capital gains, you will have a net capital loss for 2022. You can use that net capital loss to shelter up to $3,000 of this year’s higher-taxed ordinary income from salaries, bonuses, self-employment, and so forth ($1,500 if you’re married and file separately). Any excess net capital loss will be carried forward to 2023.
Selling enough loser securities to create a net capital loss that exceeds what you can use this year also might make sense. You can carry forward the excess capital loss to 2023 and beyond and use it to shelter both higher-taxed short-term gains and long-term gains recognized in those years.