The tax overhaul doesn’t change the favorable rates for long-term capital gains and many dividends, and a popular zero tax rate on these types of investment income will continue to exist.
In 2018, the zero rate will apply to married couples, filing jointly, that have up to $77,200 of taxable income ($38,600 for singles). A 15% rate then takes effect for joint filers with up to $479,000 of taxable income ($425,800 for singles), and a 20% rate applies above that. These rates and brackets are similar to those in effect for 2017.
Long-term capital gains are net profits on investments held longer than a year. As in prior law, short-term capital gains on investments held a year or less are taxed at the same rates as ordinary income.
The favorable rate for dividends applies to those that are “qualified,” which most are. Nonqualified dividends are taxed at ordinary-income rates.
How the zero rate applies
Some readers have asked how the zero rate on investment income applies. Here is a simplified example:
Say that Herbert is a single taxpayer with $30,000 of taxable ordinary income after deductions and exemptions, such as for tax-free municipal-bond interest or the sale of a home. This income is taxed at regular rates up to 12%, as detailed in the new tax brackets.
But Herbert also has a $20,000 long-term capital gain. This $20,000 “stacks” on top of his $30,000 of other income. As a result, he would owe zero tax on $8,600 of his gain and 15% on the remaining $11,400.
Surtax is left in place
Many readers have also asked whether Congress repealed the 3.8% surtax on net investment income. It did not. This levy takes effect at $250,000 of adjusted gross income for most married couples and $200,000 for most single filers.
As a result, top-bracket taxpayers typically owe 23.8% instead of 20% on their long-term gains and dividends. Some investors in the 15% bracket owe the 3.8% surtax because their adjusted gross income is above the $250,000/$200,000 thresholds, while others don’t because their income is lower.
No FIFO rule change
Lawmakers also didn’t enact a proposed provision for individual investors known as FIFO, for “first-in, first-out.” This change would have forced investors selling part of a holding in a taxable account — as opposed to a retirement account — to sell their oldest shares first, raising taxes in many cases.
Congress also preserved most tax exemptions for municipal-bond interest.