ATRA Tax Rates for Capital Gain and Dividends

January 12, 2013

The American Taxpayer Relief Act of 2013 (“ATRA”) made important changes in the way long-term capital gain and qualified dividend income are taxed. Here’s an explanation, in Q&A format.

What happened to the 0% rate?
The 0% rate for capital gain that falls below the level where the 25% tax bracket begins was set to expire in 2013. ATRA made it permanent.

How about the rate for qualified dividends? Wasn’t that going back up to 39.6%?
ATRA prevented that from happening, making the provision that taxes qualified dividend income at the same rate as long-term capital gain permanent.

Did they keep the top capital gain rate at 15%?
Only for capital gain and qualified dividend income that falls below the level of the 39.6% bracket. Above that level ($400,000 for singles, $450,000 for joint filers) the rate is 20%.

So we have three rates for capital gain now?
That’s right: 0% up to the level where the 25% income tax bracket applies, 15% from that point to the level where the 39.6% bracket applies, and 20% above that level.

I heard something about an 18% rate?
If the Bush tax cuts had expired, an 18% rate would have been available for ”qualified five-year gain.” This rate was enacted in 1997 to take effect in 2001. A subsequent law superseded this rule, giving us a 15% rate as of 2001 instead.  ATRA cancels the sunset provision in the Bush tax cut, and that means the 18% rate, which was enacted but never took effect, has been permanently repealed.

I also heard something about a 23.8% rate?
Beginning in 2013, taxpayers with income above certain thresholds will pay a 3.8% Medicare tax on net investment income. This tax applies to capital gain, so the overall tax rate on a long-term capital gain can be as high as 23.8%. And the effective tax rate can be even higher, because capital gain can cause a reduction in other tax benefits, such as itemized deductions.

Are there other rates for long-term capital gains?
Special rates for certain items, such as collectibles, remain unchanged under the new law.