Capital gains tax rates-where are they going and what should we do?

Many taxpayers are asking, “What is happening to the long-term capital gain tax rate?” or “Should I sell my security investments, real estate or business in 2010, because of the current low capital gains tax rate?”

Since 1981 the long-term capital gains tax rate has ranged from 15% to 28%. Below is a table that represents the % increase in the sales price of an asset needed to achieve the same net after tax proceeds using various capital gains tax rates.

Currently most taxpayers are subject to a 15% federal tax rate on long-term capital gains. Generally, long-term means gains from the sale of investments, real estate and/or businesses held over one year. If Congress takes no action, the rate increases to 20% in 2011. Technically, because the phase-outs of itemized deductions and exemptions will automatically increase in 2011 without Congressional action, the effective rate could be higher than 20%. Also, as a result of the recent Heath Care bill’s Medicare tax on investment income, many taxpayers will be subject to an additional 3.8% tax rate on capital gains  beginning in 2014.

Who knows if Congress will make any major changes before year end. My guess is they won’t, or if they do, the rate will be 20% or more beginning in 2011.  I will be in Washington, D.C. meeting with members of Congress over the next few months. I hope to get more insight.

If a sale of an asset subject to the long-term capital gain tax is imminent, obviously executing the sale in 2010 makes sense.

Below are some additional items to consider when analyzing what to do with other assets that would generate a long-term capital gain if sold.

1)   Start by determining when it make sense to sell from an economic standpoint, regardless of tax rates. Then begin the tax planning aspects of the analysis.

2)   If your capital loss carry forwards exceed the gains you expect to generate, no income will be generated and therefore the rate doesn’t matter.

3)   Remember, unlike capital losses, there is no wash sale rule or related party rules with regards to capital gains. Therefore you can sell an asset and immediately buy it back or sell it to a related party and generate a capital gain.

4)   If you sell your business using an installment note or obligation, you can elect out of installment reporting and pick up all gains in the year of the sale. Try to get a down payment sufficient enough to cover all or a substantial portion of the tax. Even if you have an earn out or other contingent price provision, you can value it and include as part of the gain in the year of the sale by electing out of installment sale treatment.

5)   If a transaction requires an escrow account and you want to include it in 2010 income, make sure the terms of the escrow result in constructive receipt, or treat it as a contingent price as discussed above. If the amount is later lost, you may be able to amend your return or claim a deduction under Internal Revenue Code section 1341. I recommend you extend your return for the year of sale as long as possible in order to better determine the amount of the escrow account that you will receive.

6)   Run spreadsheets to calculate the tax using various rates vs. the date tax payments need to be made to determine the best timing from a tax perspective

Odds are the 2010 rate is the lowest rate you will ever experience and selling in 2010 makes sense.

If you are interested in other tax changes that are coming in 2011 as a result of Congress taking no actions, click here.  These changes make for very interesting times and tough decisions relating to tax planning.

Send me tax or accounting related questions or issues you would like me to write about on my blog. I will try to oblige.  Watch for next weeks time sensitive reminders relating to the HIRE Act Social security tax holiday and the new home buyer credit.

Finally, last month Mick Jagger told Larry King they would most likely tour again next year. That will be almost as fun as digging into new tax law provisions.