Word of the Day – Capital Gains Tax

Capital gains tax – welfare for the wealthy

Definition: Capital gains tax is tax on profits from sales of investments

Discussion: “Income” from profits on sales of financial investments, e.g. stocks or bonds, held for less than one year is taxed at a maximum rate of 15%. The financial investments invested in are called “assets”. To owe taxes on capital gains you make from investments you must buy financial assets low and sell them high. Income you make on buying and selling investments is called portfolio income.

Non-investment assets that you make money on while holding onto them for a longer term produce a type of income called “passive income“, e.g., rents and royalties. This income too has an effective rate (after deductions) of around 15%. However, the IRS lumps together passive income along with “earned income,” into a category called “ordinary income“. Ordinary income is the opposite of capital gains income, and it is a graduated tax where you pay more tax the more you earn.

For earned income, a rate of 15% tax in 2011 puts you at the bottom of the income tax schedule, e.g., earnings of up to $34,500 if single or 69,000 if married, filing jointly. Earned income above those amounts winds up being taxed at higher rates than investment income. That’s because the capital gains tax is always 15% or less. In other words, earned income that falls between the 15% and 38% marginal tax brackets is taxed more heavily than the same amounts of income made from sale of investments held for a short time (less than one year).

In addition, if you have a loss rather than gain on your portfolio income, you can take that loss as a deduction. This is called a “capital loss”. No such deduction is allowed for a loss on earned income.

What would a loss on earned income look like? It would be a loss on the value of your wages through inflation. It could also be a loss from cutbacks in wage rates for your job, such as the cuts in pay and benefits that public employees are taking right now. If you worked the same job and same hours, but earned less during the year, you’d have a deductible loss against your taxes on earned income for that year.

“It’s not how much you make; it’s how much you keep that counts.” Ed Slott, 2010 PBS special “Lower Your Taxes Now and Forever”

Broader term: income tax

Antonym: ordinary income tax

Synonyms:  portfolio income tax; investment income tax

Related terms: earned income tax; passive income tax

Copyright © 2011 Nancy K. Humphreys


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