Are Long-Term Capital Gains Included in AGI?
Explore how long-term capital gains impact your Adjusted Gross Income and their effects on tax credits and deductions.
Understanding the tax implications of long-term capital gains is crucial for investors and taxpayers. These gains, arising from the sale of assets held for over a year, impact taxable income and influence overall tax liability through their treatment in Adjusted Gross Income (AGI).
Calculation of Capital Gains
Capital gains are calculated by subtracting the cost basis—the original purchase price of an asset—from the sale price. For instance, if an investor buys shares for $5,000 and sells them for $8,000, the capital gain is $3,000. Adjustments, such as stock splits or dividends, can modify the cost basis, affecting the final gain or loss.
Assets held for more than a year qualify for long-term capital gains treatment, which benefits from lower tax rates compared to short-term gains. As of 2024, these rates are 0%, 15%, or 20%, depending on income level, offering a distinct advantage over ordinary income tax rates applied to short-term gains from assets held for one year or less.
Certain exclusions or exemptions can reduce taxable gains. For example, under IRS Section 121, the sale of a primary residence may qualify for an exclusion of up to $250,000 ($500,000 for married couples filing jointly).
Specific Forms for Reporting
Taxpayers report long-term capital gains using specific IRS forms. IRS Form 8949 is the primary form for documenting sales and dispositions of capital assets, requiring details such as acquisition and sale dates, cost basis, and proceeds.
Information from Form 8949 is summarized on Schedule D (Form 1040), which consolidates all capital gains and losses. Schedule D determines the net capital gain or loss for the year and applies any capital loss carryovers from prior years to offset gains. This can reduce taxable income and applies the preferential long-term capital gains tax rates.
Inclusion in AGI
Long-term capital gains are included in AGI, a key figure in the U.S. tax system that affects deductions, credits, and overall tax liability. Including these gains in AGI can push a taxpayer into a higher tax bracket, increasing the marginal tax rate on ordinary income. Substantial gains may also trigger the 3.8% Net Investment Income Tax (NIIT) if modified AGI exceeds certain thresholds.
Higher AGI from capital gains can impact eligibility for tax credits and deductions. Many credits, such as the Child Tax Credit or the American Opportunity Credit, have income phase-out limits tied to AGI. Strategic tax planning, such as timing asset sales or using tax-loss harvesting, can help manage AGI and preserve eligibility for these benefits.
Effect on Credits and Deductions
The inclusion of long-term capital gains in AGI can limit certain credits and deductions. For instance, the Earned Income Tax Credit (EITC), designed for low to moderate-income workers, is phased out as AGI increases, potentially disqualifying taxpayers with significant capital gains.
Deductions subject to income thresholds are also affected. For example, the medical expense deduction allows taxpayers to deduct qualified expenses exceeding 7.5% of AGI. Higher AGI raises this threshold, reducing the deduction’s potential benefit. Although the phase-out of itemized deductions under IRC Section 68 is temporarily suspended until 2025, the relationship between AGI and deductions underscores the importance of managing taxable income.
High-Income Considerations
High-income taxpayers face additional complexities in the treatment of long-term capital gains. The Alternative Minimum Tax (AMT), designed to ensure high earners pay a minimum tax, includes long-term capital gains in its calculations, potentially raising the overall tax burden despite preferential rates.
The Net Investment Income Tax (NIIT) applies a 3.8% surtax on investment income, including long-term capital gains, for individuals with AGI exceeding $200,000 ($250,000 for married couples filing jointly). To mitigate these surtaxes, high-income taxpayers can explore tax-efficient strategies, such as investing in municipal bonds or utilizing tax-deferred accounts, to manage their taxable income effectively.