The 0% Tax Secret

tax savingsMost middle-income Americans can’t believe there’s a loophole that could cut their taxes on capital gains and stock dividends to absolutely zero.

But it’s true.

A little known loophole

The 0% tax rate is a little known loophole hidden in the tax code. It benefits lower and middle-income taxpayers in the two lowest tax brackets, meaning those people normally paying 10% and 15% tax on ordinary income like wages or Social Security.

In dollar terms, that covers married couples with taxable income (after deductions) of up to $74,900, singles up to $37,450, and head of household filers with taxable income up to $50,200.

If you qualify, you would pay 0% tax on long-term capital gains (sales of assets held over 1 year) and 0% tax on qualified dividends (usually dividends on stocks and stock funds).

Life in the tax-free zone

Take a retired couple making $70,000 to $80,000 in income. After deductions and other exemptions are factored in, their taxable income might drop to $60,000, putting them firmly in the 0% tax zone. That allows them to sell appreciated stock, or receive stock dividends, tax-free.

Your tax preparer will automatically take advantage of the 0% tax rate if you qualify (and as always with the IRS, conditions and caveats apply). But to take full benefit of this incredible loophole, clients will want to provide us with a copy of their previous year’s tax return as soon as possible so we’re aware of their tax status. If we know you’re potentially in the tax-free zone, we can help you harvest long-term gains – all for free. Otherwise, it’s an opportunity lost.

Smart tax scenarios

Here’s examples of how smart clients have taken advantage of this tax-free window.

Melissa, the daughter of a long-time client, was just starting out at her first “real” job, and had a low entry-level salary. She had shares of stock that were gifted to her years ago. She hadn’t wanted to sell because of big long-term gains. But by using this loophole, and selling before her working income got too high, she was able to liquidate the stock, and reinvest in a more broadly diversified stock portfolio – all with no capital gains taxes.

Gail, a recently divorced mom, was financially on her own for the first time in years. Working just part-time, she was struggling to stay within her new, reduced budget. As part of the divorce, she received shares of a tech stock that had gone up in value since it was first purchased, but didn’t fit her new moderate-risk growth-and-income investment objective. Gail was able to sell all of the stock, pay no tax, and buy lower-risk dividend-paying stocks to supplement her income.

Fred and Alice lived frugally on Social Security benefits and limited investment income, primarily from CDs. But they also had shares of an insurance company stock that they received as policy holders. They never sold the stock, because they didn’t want to pay the capital gains. But they felt it hadn’t done that well as an investment, and they would have preferred to invest in a better-quality portfolio of blue-chip stocks. The solution? Given their low tax bracket, they were able to sell all the stock with no taxes and reinvest in a low-cost blue-chip mutual fund. The icing on the cake? The qualified stock fund dividends are also likely to be tax-free.

About Mari Adam

Mari Adam, Certified Financial Planner™ and President of Adam Financial Associates Inc, has been helping individuals and families chart their financial futures for over twenty-five years. Have a question about your financial situation? Ask Mari!

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