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Congress has passed a massive tax cut package that gives special relief to investors. Lower capital gains tax rates and an exclusion for stock dividends eases the tax burden on those who realize investment gains in taxable accounts. However, investors still have to manage the tax impact of their investments correctly in order to maximize their gains.
Under the new law, any long-term capital gain realized through an investment sale after May 6 will be taxed at no more than a 15% rate, rather than the former 20% maximum rate. Very low-income taxpayers saw their capital gains rate cut to 5%. In addition, dividends received from stocks will be taxed at a maximum 15% tax rate, rather than at personal income tax rates as high as 35%.
Investors have long had a lower tax rate applied to long-term capital gains, currently defined as gains on investments held for a year or more. Short-term gains on investments held less than a year are subject to higher ordinary income rates. The new long-term gain rates increase the value of long-term over short-term gains. The spread between the 15% long-term gains rate and the maximum ordinary income rate is now 20 percentage points, higher than the 18.6 percentage point rate under previous law.
The lower rate on qualified dividends means that investors should better manage the income from investments. They should make a taxable investment account the first choice to hold investments that produce qualified dividends, while a tax-deferred account will be preferred for investments such as real estate investment trusts and corporate bonds that produce non-qualified dividends or ordinary interest.
Despite the lower rates, investors should remember that taxes are still a factor. Investors who hold investments for the long-term will pay less tax than those who trade actively.