Capital Gains Taxes for 2011 – What is changing and when?

By Melina Triplett, TradeLog Support Agent

With so much talk about the economy, debt ceiling, taxes and spending, it is important that traders understand the capital gains tax rules that affect them. In this article I’ll review the current tax cuts that traders and investors benefit from, as well as the future standing of capital gains taxes beyond 2011.

Many of you followed the tax debates last year that resulted in President Obama’s “last minute” signing of the Tax Relief, Unemployment Insurance Authorization and Job Creation Act of 2010 which essentially extended the tax cuts former President George W. Bush instituted in 2006.

These tax cuts were supposed to run out in 2010 meaning a considerable tax rate hike for tax payers to virtually no cost for the government in 2011. If it wasn’t for the extension, starting in 2011, taxes would have gone back up to rates before Bush era tax cuts. The good news is, as it stands now, many tax payers get to enjoy favorable tax rates for two additional years. The bad news is, these tax cuts will expire. Let’s now look at these cuts and how they affect capital gains.

On May 17, 2006 President George W. Bush signed the Tax Reconciliation Act which lowered tax rates for long-term capital gains to 15%, and to 5% for individuals in the lowest two income tax brackets. Instead of letting these tax cuts expire in 2008, they were extended through 2010 and expanded by lowering the long-term capital gains tax rate even further to 0% for those in the lowest two income tax brackets. The long-term capital gains tax rate for those in the 25% federal income tax bracket or above, remained at 15%. These rates will remain unchanged for another two years, expiring at the end of 2012. What did change in 2011, however, are the actual tax brackets – they were adjusted due to inflation.

So what exactly will change when the tax cuts expire at the end of 2012? If the expiration takes its course with no new legislation, there will be significant changes in many tax areas. Let’s focus on two major adjustments:

Ordinary Income Tax Rates:

Up until 2012, the tax brackets were categorized as 10%, 15%, 25%, 28%, 33% and 35%. From 2013 onward, there will no longer be a 10% tax bracket. The 15% tax bracket will then be the lowest tax bracket and swallow up the tax payers in the 10% tax bracket. The remaining tax rates will all see an increase of 3 points with the exception of the highest tax bracket, which will be hit with a 4.6% increase. Consequently, the new tax rate categories will be 15%, 28%, 31%, 36% and 39.6%.

Short-term capital gains will be taxed according to the ordinary income tax rate. Therefore, they will also be affected by the increase in rates.

Long-Term Capital Gains Rate:

After 2012, tax payers in the lowest two income tax brackets will have to face an increase in their long-term capital gains rate from 0% to 10%. In the remaining tax brackets the increase will “only” be by 5% – namely from 15% to 20%.
Noteworthy also, is that after 2012 the qualified five-year 18% capital gains rate (8% for taxpayers in the 15% tax bracket) will be reinstated.

The chart below highlights the key changes in capital gains tax rates:

With the ongoing debates in Washington we can never know for sure what the future holds, but as it stands the current tax cuts will come to an end so enjoy them now. There are many other changes to the tax code that affect traders and how they file taxes. Check out our online Tax Topics as well as keep up with news at blog.tradelogsoftware.com to stay in the know!