Spreading income over two tax years
Depending on your tax bracket, the tax rate on long term capital gains and qualified dividends ranges from 0% - 20%. The tax rates on ordinary income range from 0% - 37%. You can deduct losses up to $3,000 with any excess loss carried forward. Should you wish to reinvest in the same stock, either it’s best to do so 30 days before or 30 days after the sale to avoid wash sale rules, which would disallow the loss.
The modified proposal is to keep the top income tax rate at 37% but introduce surtaxes for high earners. Current proposals are to have a 5% surtax for Married Filing Jointly (MFJ) taxpayers with Modified Adjusted Gross Income (MAGI) of over $10 million, plus a 3% surtax for MFJ taxpayers with MAGI of over $25 million. So for the highest earners this means a top rate of federal income tax of 45%. In terms of capital gains, Biden had proposed an increase to long-term capital gains rates to 25% beginning midway through 2021, however the modified bill has removed this increase.
What should you do?
By spreading capital gains/income between tax years, you can abstain from incurring spikes in income, which may push gains/income into the higher tax brackets. This may help minimise the total tax paid for those tax years. You may also want to consider realising some capital losses to reduce tax on other investment income and gains.
As there is a potential chance of tax rates increasing, particularly for higher income earners, you may want to consider accelerating income in 2021. An investment decision should also be made, and there is the possibility of disposing of and reacquiring an asset, but we advise that you seek advice tailored to your unique circumstances.
Net Investment Income Tax (NIIT)
You may continue to incur an additional tax of 3.8% on unearned investment income, where your Modified Adjusted Gross Income (MAGI) exceeds the following thresholds:
What should you do?
By spreading investment income across a number of years or offsetting it by above the line deductions, you can prevent the requirement of paying the additional 3.8% NIIT by keeping your total income under the NIIT thresholds. To do this, you could consider paying a dividend or realising capital losses.