Capital gains tax

From Wikicpa

A capital gains tax (abbreviated: CGT) is a tax charged on capital gains, the profit realised on the sale of an asset that was purchased at a lower price. The most common capital gains are realised from the sale of stocks, bonds, precious metals and property. Not all countries implement a capital gains tax.

In the United States, individuals and corporations pay income tax on the net total of all their capital gains just as they do on other sorts of income, but the tax rate for individuals is lower on "long-term capital gains", which are gains on assets that had been held for over one year before being sold. The tax rate on long-term gains was reduced in 2003 to 15%, or to 5% for individuals in the lowest two income tax brackets. Short-term capital gains are taxed at a higher rate: the ordinary income tax rate. In 2013 these reduced tax rates will "sunset", or revert back to the rates in effect before 2003, which were generally 20%.

Technically, a "cost basis" is used, rather than the simple purchase price, to determine the taxable amount of the gain. The cost basis is the original purchase price, adjusted for various things including additional improvements or investments, taxes paid on dividends, certain fees, and depreciation.

Exemptions from capital gains taxes (CGT) in the United States include:

An individual can exclude up to $250,000 ($500,000 for a married couple filing jointly) of capital gains on the sale of real property if the owner used it as primary residence for two of the five years before the date of sale. The two years of residency do not have to be continuous. You can meet the ownership and use tests during different 2-year periods. However, you must meet both tests during the 5-year period ending on the date of the sale. There are allowances and exceptions for military service, disability, partial residence and other reasons. See IRS Publication 523.

If an individual or corporation realizes both capital gains and capital losses in the same year, the losses cancel out the gains in the calculation of taxable gains. For this reason, toward the end of each calendar year, there is a tendency for many investors to sell their investments that have lost value. For individuals, if losses exceed gains in a year, the losses can be claimed as a tax deduction against ordinary income, up to $3,000 per year. Any additional net capital loss can be "carried over" into the next year and again "netted out" against gains for that year. Corporations are permitted to "carry back" capital losses to off-set capital gains from prior years, thus earning a kind of retroactive refund of capital gains taxes.

The IRS allows for individuals to defer capital gains taxes with tax planning strategies such as the charitable trust (CRT), installment sale, private annuity trust, and a Section 1031 exchange.

The United States is unlike other countries in that its citizens are subject to U.S. tax on their worldwide income no matter where in the world they reside. U.S. citizens therefore find it difficult to take advantage of personal tax havens. Although there are some offshore bank accounts that advertise as tax havens, U.S. law requires reporting of income from those accounts and failure to do so constitutes tax evasion.

[edit]

Criticisms

It is sometimes claimed that capital gains tax in conjunction with income tax is a case of double taxation. In the United States, income subject to capital gains tax treatment is excluded from ordinary income taxation by 26 USC § 1(h) [1], and so it is legally impossible to doubly tax capital gains under that law.

Broadly speaking the value of capital relates to the future income that the capital is expected to produce. Any increase in the value of capital hence relates to an expected increase in future income. However this additional future income is already subject to income tax so the capital gain is already fully taxed.

This argument is somewhat acknowledged by the fact that no CGT applies if ownership of the capital (that will produce the future income) does not change hands. In other words CGT does not apply if the capital gain is not realised through a sale.

There are some weaknesses in the double taxation argument. Specifically many items that are subject to Capital Gains Tax are not expected to produce any future income. Things such as works of art and precious artifacts increase in value for reasons other than associated future income.

[edit]