No one wants to pay more in taxes than they should. In order to keep your tax bill as low as you can, it pays to stay on the lookout for opportunities to keep your tax rates as low as possible.
For years, some investors have been able to earn certain types of investment income without paying any taxes at all. But with the coming fiscal cliff looming, a valuable tax break could disappear entirely.
How Low Can You Go? All the Way to Zero
For about a decade, all investors have enjoyed lower rates on qualified dividends and long-term capital gains -- the profit you make when you sell an investment for more than you paid for it. When lawmakers passed the Bush tax cuts in 2003, they set the dividend rate and the long-term capital gains rate at the same level: 15%. The move was an especially huge cut for dividends.
But what many people don't realize is that an even lower rate applies for people who are in the lowest two tax brackets. Under current law, joint filers with taxable income up to $70,700 and single filers with income up to $35,350 pay nothing in taxes on qualified dividends and long-term capital gains.
A Limited Tax Break
If you're in those income brackets, though, you can't get infinite tax-free gains. The 0% rate applies only up to the top end of the 15% tax bracket. Beyond that, you'll pay the standard maximum rate of 15%.
But for many taxpayers, that leaves a lot of room to pull in tax-free gains. If you file jointly and have taxable income of $60,000, for instance, you could take up to $10,700 in additional capital gains without paying a cent of tax. That can add up to huge tax savings; if you chose to take those gains in a year when the 0% rate doesn't apply, those gains could cost you more than $1,600 in taxes -- or more, if scheduled tax increases take effect.
Unfortunately, 2012 may be the last year that the 0% tax rate will exist. Unless lawmakers make changes, both capital gains and dividend rates will rise dramatically in 2013, with dividends returning to their old treatment as ordinary income. Capital gains rates will rise to 20%. So if you have room to take tax-free gains by selling profitable investments, don't wait: Get it done before the year ends.
Motley Fool contributor Dan Caplinger used the 0% rate to its fullest back when he was eligible for it.