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It has been universally reported that under the newly passed American Taxpayer Relief Act of 2012, net capital gain tax rates have risen to 20% for taxpayers with taxable income greater than $400,000 for single filers and $450,000 for joint filers. To clarify this broad statement, under section 102 of the new law, the higher capital gains rate applies only to the gain that, when added to other taxable income, exceeds the threshold amounts. Taxpayers below the 39.6% taxable income threshold before capital gains are taken into account will have their capital gains taxed at 15% up to the taxable income threshold and 20% on the excess. The following two examples illustrate how the net capital gain tax rate is calculated:
In Example 1, joint taxpayers earn $400,000 of ordinary income and another $200,000 in net capital gains. Under the new law, the first $50,000 of net capital gains is taxed at the lower rate, with the remaining $150,000 taxed at the higher rate. The effective rate of 18.75% reflects the blending of the 15% and 20% rates.
In Example 2, joint taxpayers now earn $200,000 of ordinary income and another $400,000 in net capital gains. Because a greater portion of the taxpayers' taxable income has shifted from ordinary income to net capital gain, the effective net capital gain rate is lower than the previous example because a greater portion of the taxpayer's below-the-threshold income is taxed at the 15% rate, leaving a smaller remainder subject to the 20% tax.
The above examples do not take into account the new 3.8 % medicare surtax on capital gains (and other net investment income) imposed by section 1411 of the Internal Revenue Code. Because the income threshold under that section is lower than the 39.6% tax rate threshold ($200,000 for single filers and $250,000 for joint filers), the surtax would apply to the entire net capital gain amounts in both examples, resulting in an effective rate of 22.55% and 20.68% respectively.