Financial Planning, Millennials

Can Capital Gains Taxes Push Me Into A Higher Tax Bracket?

As an investor, you get taxed on the gains you receive from selling an investment. This should be something you know by now (and if you want to learn more about how you are taxed, check out this article)

The way you are taxed is decided by how long you hold the investment for. If you sell within 1 year, you are taxed at short term capital gains rates which are the same as your income rate as seen below. 

However, if you hold an investment for greater than 1 year, you are taxed at long term capital gains rates, which as you can see from the chart underneath, are more favorable than short term capital gains rates. 

Now that you understand how an investment gets taxed, let’s look at the question “can capital gains push you into higher tax brackets?” 

The answer is… it depends. It’s based on how long you hold your investment for. 

If you hold on for greater than 1 year, then it will not push you into a higher tax bracket. Long term capital gains get taxed at its own rates and do not cause your ordinary income to be taxed at a higher rate. (Note: it can raise your Modified adjusted gross income (MAGI) and phase you out of certain deductions, ROTH IRA limits, etc.)

But, if you hold on for less than 1 year, it will. Short term capital gains are added to your ordinary income and are taxed at ordinary income tax rates. This leads to your Adjusted gross income (AGI) increasing which then can lead to you being phased out of itemized deductions, certain tax credits, and even push you over the limit to contribute to a ROTH IRA. 

Let me show you how. Let’s say your AGI is $160,000 and you are single. Right now your marginal tax rate (the amount of tax you owe on your next dollar) is 24%. Now let’s say that you sold an investment for a gain of $20,000 that you held onto for 6 months. This would increase your AGI to $180,000 pushing you into the 32% bracket. $4,926 would be used to fill up the rest of the 24% tax bracket, then the remaining $15,074 would be taxed at 32%. 

As you can see, short term gains can and do move you into higher tax brackets. This is something you want to be aware of so you know how much to save for the tax bill you will owe!

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Disclaimer: none of this is advice, it is just for informational purposes. Talk with your financial planner before implementing any of these strategies.