Capital gains taxation

 

Long-term capital gains and dividends are taxed at special lower rates. The best way to understand this is to look at the tax rate charts for ordinary income and for capital gains and run some examples.

A middle-income person, with income of say $50,000 for a single person or $100,000 for a married person, would pay a marginal tax rate of 22% on ordinary income, and 15% for capital gains. (Note, to interpret the capital gains tax rate charts, understand that your bracket depends on total income, not just capital gain income).

The difference is bigger for higher incomes. If my income is a million dollars, then capital gains would be taxed at their maximum marginal rate—but that's still only 20%. Meanwhile, ordinary income would be taxed at a marginal 37%.

You often hear capital gains taxation discussed as something that only benefits the rich. This is mostly true, because rich people are more likely to have capital gains income, if only because they can afford to hold more investments. And because they can afford expensive accountants who can advise them on tax avoidance strategies. But in theory, the poor can benefit from capital gains tax rates too. If I make $10,000, my income tax marginal rate is only 12%, but I can get capital gains for 0%. This is why some people argue that the ideal income is precisely $80,000 in capital gains and no other income—this would allow you to have a generous $80,000 to live on, with a federal income tax rate of zero.

If you're doing your own taxes, reporting capital gains is going to be a little bit harder. You have to track gains versus losses, long-term vs. short-term, and your brokerage can report these things in several different ways. Or not report them at all, if you've got crypto gains or losses :) But it's all quite feasible!

Note—most of this discussion does not apply to short-term capital gains, which are taxed like ordinary income. Short-term means held for less than a year.