So I met with my accountant yesterday and we discussed selling some stock to diversify my portfolio. I was asking about capital gains tax, and she told me that it’s not based on my salary or ordinary income but just the income from capital gains. Florida doesn’t have state tax, so I’m just focusing on long-term federal capital gains tax. But when I googled it, I started to wonder if I misunderstood. Can someone explain this clearly for me?
She said the capital gains are not based on salary / ordinary income but rather just the income from capital gains.
This is correct. I was confused by this at first too, but I realized what she meant. To clarify, this doesn’t mean the tax rate on your capital gains will stay the same regardless of your income. It actually depends on how much other income you have, since it affects where your capital gains tax starts. But in general, your capital gains are a separate thing and don’t change based on your salary or how much you make. For example, if you buy stock for $1,000 and sell it for $1,200, you have $200 in capital gains, no matter how much other income you have. Your income will affect how much tax you owe on that gain, but the gain itself stays the same.
Thanks, I think I get it now. So, the capital gain stays the same no matter what, but the rate I pay depends on how much total income I have, right? Is that the idea?
Sky said:
Thanks, I think I get it now. So, the capital gain stays the same no matter what, but the rate I pay depends on how much total income I have, right? Is that the idea?
Yes, exactly. Short-term capital gains and your regular income are taxed at the same rate, but long-term capital gains get taxed at a lower rate, depending on your total income. If your total income (including short-term gains) is low enough, you might even pay 0% tax on your long-term gains. But if you make more, your capital gains get taxed at 15% or more. It’s all about your total income level, not just the capital gain itself.
Sky said:
Thanks, I think I get it now. So, the capital gain stays the same no matter what, but the rate I pay depends on how much total income I have, right? Is that the idea?
Not quite. The rate at which long-term capital gains (LTCG) are taxed depends on how much taxable income you have before counting your capital gains. It’s not about which tax bracket your ordinary income falls into, it’s more about the total amount of taxable income you have and how much long-term capital gains you have.
It’s a little more complicated, but here’s the simple version: Take your adjusted gross income (AGI) and subtract your capital gains. Then you look at the capital gains tax table to figure out how much tax you owe. For example, if your AGI without capital gains is $40,000 and you have $7,000 in long-term capital gains, those gains will be taxed at 0%. Anything above that will be taxed at 15%. It’s simple enough for most people, but if you’re dealing with more complicated finances, it can get trickier.
Can you explain how this affects ordinary income tax? For instance, if my AGI without capital gains is $90k and I made a $20k long-term capital gain, that brings my total income to $110k. The top ordinary income tax rate is 22% up to $100k, but will I still pay 22% on my $90k income, or will that extra $10k be taxed at 24% because it pushes me into the next tax bracket? I also assume the $20k in LTCG gets taxed separately at the 15% rate?
You’ve got the right idea. It’s kind of like two separate buckets. Your W-2 income and short-term capital gains are taxed together at your normal income tax rate. But long-term capital gains are taxed separately, depending on your filing status and overall income for the year. So your ordinary income stays at the 22% rate up to $100k, and then the long-term capital gains are taxed separately, probably at 15%, depending on your total income.
Thanks, that makes sense now!
Just to clarify, you won’t pay any capital gains tax until you actually sell the stock. For example, if you buy stock for $50 and it goes up to $100 after five years, you won’t owe any tax until you sell it. When you sell it, you’ll pay tax on the $50 gain, assuming it’s long-term capital gains tax.
The tax you pay will depend on how much you sell and how much the stock has increased in value. Your brokerage will send you a tax form to include when you file your taxes.
Long-term Capital Gains (Federal):
For example, you invested $1,000 in stock and after holding it for over a year, it’s worth $2,000. If you sell it, the $1,000 profit is what you’ll be taxed on. If your long-term capital gains tax rate is 15%, you’ll pay $150 in taxes and keep $850. Your income doesn’t affect this, but it will affect the rate of tax if you have a high income.
I’m not sure that’s how it works for everyone…
For most people, long-term capital gains are taxed at a flat 15% rate.
If you want the simplest answer: your gains are taxed at 15%. If you’re making under ~$47k (as a single filer) after the standard deduction, you might not owe any tax on your sale.
Here’s how your taxes are calculated:
Short-term capital gains are taxed as regular income (20%).
Long-term capital gains are taxed at 15%.
Qualified dividends count as long-term capital gains.
Unqualified dividends and interest are regular income.
Your paycheck is regular income.
All of this adds up to your total income, and then the standard deduction is subtracted. After any other deductions, you have your adjusted gross income (AGI). Then you use the IRS tax brackets to figure out your tax. You can subtract any taxes already paid by you or your employer, and the difference is what you owe, or what you get refunded if you’ve overpaid.