Most people are very familiar with the idea of ordinary income: it is the money that an individual receives in the form of wages, tips, dividends, or interest from an interest-bearing account, such as a savings account.
Many people might not understand what is meant by “capital gains,” however. The difference between the two is more than just academic since capital gains are taxed at a much lower rate than ordinary income. Thus, a person who receives money in the form of capital gains will have to pay significantly fewer taxes on that money than someone who receives the same amount of money as ordinary income.
Capital Gains are Investment Profits
Simply put, capital gains are profits that an individual receives from an appreciation in the value of an investment. To state that another way, capital gains are the difference between the sale price of an investment and the original purchase price of that investment. The investment can be any kind of capital asset – usually stocks, bonds, or real estate.
The capital gain is only realized once the capital asset has been sold, so people with investments in capital assets do not have to pay taxes on assets that have gone up in value as long as they have not received any income from that asset (like a stock dividend, for example). As soon as the owner sells the asset, however, any capital gains become subject to taxation.
You need to keep track of your assets, what you paid for them and what you sold them for. If you don’t do this, you won’t be able to calculate your basis and the IRS could charge you tax for the entire amount of the sale of the asset, rather than just your gain.
Maximum Rate of Fifteen Percent
The current maximum tax rate for capital gains is 15 percent, while the maximum tax rate for ordinary income is 35 percent. There are two justifications that are usually given for this disparity: first, proponents of the lower capital gains rate argue that the lower rate will provide an incentive for people to invest, which will drive economic growth. Second, supporters of the low rate argue that the lower rate is necessary to reduce the effect of inflation on the investment.
To illustrate that last concept, consider that someone may hold onto a capital investment for a long period of time. During that time, inflation may decrease the real value of the investment, even though the price may rise. According to its proponents, a lower capital gains tax is necessary to offset the impact of inflation on capital assets.
Free Consultation with a Utah Tax Attorney
If you are here, you probably have a tax law issue you need help with, call Ascent Law for your free tax law consultation (801) 676-5506. We want to help you.
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West Jordan, Utah
84088 United States
Telephone: (801) 676-5506