Significant Income Events/Changes and How they affect tax liability
Large capital gains or significant losses to income in a year can dramatically alter your tax liability. These financial changes can affect tax brackets, eligibility for deductions and credits, and other critical aspects of your tax return. Here’s what you need to know to navigate the tax implications effectively.
Understanding Capital Gains and Income Losses
Capital Gains: Capital gains occur when you sell an asset, such as stocks, real estate, or other investments, for more than its purchase price. They are categorized as:
Short-Term Capital Gains: For assets held one year or less, taxed as ordinary income rates.
Long-Term Capital Gains: For assets held more than one year, taxed at preferential rates depending on your taxable income.
Income Losses: Significant losses to income can result from job loss events, reduced business revenue, or investment losses. These losses can lower your overall tax liability and provide opportunities to engage certain tax strategies, as outlined below.
How Large Capital Gains Impact Tax Liability
Increased Taxable Income: A large capital gain raises your taxable income, potentially pushing you into a higher tax bracket. While long-term capital gains have separate tax rates, higher overall income can affect other parts of your tax situation.
Medicare Surtax: If your adjusted gross income (AGI) exceeds a certain threshold you may owe a Medicare surtax on net investment income, including capital gains.
Phaseouts of Deductions and Credits: Higher income can reduce eligibility for certain deductions and credits, such as the Child Tax Credit, education credits, or IRA contribution deductions.
State Taxes: Many states tax capital gains as ordinary income, which can add to your tax burden.
Alternative Minimum Tax (AMT): Large gains can trigger the AMT for some taxpayers, leading to higher taxes.
How Significant Income Losses Affect Tax Liability
Lower Tax Bracket: Reduced income can place you in a lower tax bracket, decreasing your overall tax liability.
Maximizing Deductions and Credits: Lower AGI can increase eligibility for income-based tax credits and deductions, such as the Earned Income Tax Credit (EITC) or the Saver’s Credit.
Loss Carryovers: Investment losses exceeding your capital gains can offset up to $3,000 of ordinary income per year, with remaining losses carried forward to future tax years.
Net Operating Losses (NOLs): Business owners experiencing significant losses may qualify for NOL treatment, which can offset taxable income in future years.
Strategies for Managing Tax Implications
Depending on whether you have experienced a Capital Gain Event or are experiencing a loss, there are different strategies you can use to reduce the impact of the event on your tax liability- especially when planning ahead.
For example, it may be possible to delay or accelerate income and deductions based on expected income changes. There are also ways to offset capital gains with capital losses by selling assets that you have experienced losses on (and then reinvesting in something that aligns more successfully with your investment strategy for future growth!).
You can also maximize retirement contributions to tax-advantaged accounts (such as 401(k)s or IRAs) to lower taxable income. There are also opportunities to make charitable donations of appreciated assets which not only serves the charity but also allows you to avoid capital gains taxes (Read here to learn more about how tax savings strategies through charitable giving).
How We Can Help
Whether you’re experiencing a financial windfall or a setback, understanding how large capital gains or significant income losses affect your tax liability is essential. With proactive planning and guidance from our tax experts at Visibility you can mitigate tax burdens, maximize opportunities, and better prepare for the future. Schedule an appointment with us today to learn more!
