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Did you know that you can sell
a stock at a profit and pay next to nothing in capital gains tax? Or
that you may not owe any tax on dividends you receive? It's true.
The Tax Increase Prevention and Reconciliation Act (TIPRA), which
was signed into law in early 2006, reduces capital gains and
dividend tax rates even further down to 0% in some cases. Read on to
find out more and how you can save money through proper planning.
Capital gains tax must be paid when you sell an asset for a profit.
For instance, if you buy a stock at $10 per share and sell it two
years later for $15 per share, there is a $5 per share gain that is
subject to tax. Most of us know that the maximum capital gains tax
rate is 15%. But depending on your income, your capital gains rate
might be 0%.
Your capital gains tax rate is based on your overall income tax
bracket. If your overall tax bracket is greater than 15%, then your
capital gains will be taxed at the maximum capital gains rate of
15%. Even if you are in the 35% tax bracket, you still only pay 15%
on capital gains. But if you are in the 10% or 15% overall income
tax bracket then your capital gains tax rate is only 5%!
There is also a big difference between the way that dividends and
interest are taxed. Dividends are paid by preferred and common
stocks. Interest is paid on bonds and Certificates of Deposit.
Interest is taxed at your overall income tax rate, as are any gains
from annuities. But dividends aren't. Just like capital gains,
qualified dividends are taxed at a maximum rate of 15%. If you are
in the 10% or 15% overall income tax bracket then your dividend tax
rate is also only 5%!
TIPRA, passed in early 2006, changed this. Between 2008 and 2010,
the maximum dividend and capital gains tax rate stays at 15%. But it
drops to 0% for those in the 10% or 15% overall tax brackets. You
can have capital gains and receive dividends and NOT pay any tax on
them!
Assuming 2006 tax rates, you can have $61,300 in income (married
filing jointly) and still be in the 15% overall tax bracket. You can
have $60,000 in income and you will only pay 5% in tax on dividends
and capital gains! Between 2008 and 2010 you wouldn't have to pay
ANY tax on dividends and capital gains. It's the same for those who
are single if they have $30,650 or less in income.
How should this affect your investments?
Regardless of your overall tax bracket, dividends and capital gains
are more valuable than interest because of the tax savings. Let's
say that you have the option of putting $10,000 into a Certificate
of Deposit at 5% or a preferred stock that pays a 5% dividend. At
the highest overall tax bracket, you will owe about $175 in taxes on
the CD interest, leaving you $325 to spend.
You will only have to pay about $75 in taxes on the dividend from
the preferred stock, giving you $425 to spend. That,s $100 more just
off of a $10,000 investment. In percentage terms, you have 30% more
to spend with the dividend-paying investment than with the
Certificate of Deposit.
For those in the highest tax bracket, to produce the same spendable
amount, a Certificate of Deposit would have to earn around 6.25%, or
5.75% for those in the 25% tax bracket.
It's possible to find dividend-paying investments that currently pay
far more than Certificates of Deposit. For instance, I use several
stocks for my clients that pay dividends of 7-10%. They may
fluctuate in value whereas a Certificate of Deposit does not, but
properly diversified and managed, they are a great way to receive a
larger income stream from your investments. When taxes are taken
into account, the amount of spendable income is close to double that
provided by the CD.
The bottom line is this. If you pay any income taxes at all, you are
better off (tax-wise) receiving dividends and capital gains than
interest. That's even more true in 2008 when the minimum capital
gains and dividend rate drops to 0%.
Nationally-syndicated financial columnist and Certified Financial
Planner(R) Jeffrey Voudrie provides personal, in-depth money
management services and advice to select private clients throughout
the USA. He'll answer your financial question FREE at
www.guardingyourwealth.com. |
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