If you’re new to California or new to capital gains, you may be surprised to learn that, unlike the federal government, California taxes all capital gains as income.
It’s a tax law that can end up costing you a lot of money if you fail to include it in your tax planning. That’s why it’s so important to hire a competent tax and estate planning attorney like Jennifer Reardon at the Reardon Law Firm to help you avoid pitfalls you may not even know exist.
What are capital gains taxes?
Capital gains taxes are the taxes you pay after selling an asset that has increased in value.
There are two types of capital gains:
- Short-term capital gains are things you sell less than a year after acquiring them.
- Long-term capital gains are assets you sell after a year or more of owning them.
Federal capital gains tax rates typically reward long-term capital gains with a lower tax rate than short-term capital gains. In California, however, they are taxed at the same rate.
How are capital gains taxed in California?
All capital gains in California will be taxed as income, regardless of whether they are short-term or long-term gains.
This means your capital gains will be taxed between 1 and 13.3 percent — the same rate as normal income — in addition to federal capital gains and income taxes.
California tax brackets for single person filing are:
- $0 – $8,809: 1 percent
- $8,809 – $20,883: 2 percent
- $20,883 – $32,960: 4 percent
- $32,960 – $45,753: 6 percent
- $45,753 – $57,824: 8 percent
- $57,824 – $295,373: 9.3 percent
- $295,373 – $354,445: 10.3 percent
- $354,445 – $590,742: 11.3 percent
- $590,742 – $999,999: 12.3 percent
- $1 million or more: 13.3 percent
How does the federal government tax capital gains?
The key difference between California’s capital gains taxes and federal capital gains taxes is the way the IRS rewards you for not selling your assets too soon.
Short-term capital gains are typically taxed by the IRS at the same rate as your normal income:
- The time the IRS counts for short-term versus long-term capital gains starts the day after you acquire the asset in question and ends the day you sell it.
- The tax rates for short-term capital gains mirror federal income tax rates, so anywhere from 10 percent to 37 percent depending on your income and filing status.
The reward for holding on to your assets for more than a year could mean that you pay nothing in federal capital gains taxes — or if you’re a high earner, you could save as much as 17 percent.
Proposed changes to federal capital gains taxes
President Biden, in his American Families Plan, proposes increasing the federal income tax rate for the nation’s wealthiest to 39.6 percent — and if you make more than $1 million a year or your asset in question is worth more than $1 million, your short-term and long-term capital gains would also be taxed at 39.6 percent.
He also proposes eliminating the “stepped-up basis” for taxing estates after people pass away.
What does this mean? Let’s say a family member dies and leaves you a stock that they bought for $100,000 but increased in value to $500,000 by the time they died. Instead of paying capital gains taxes on the $400,000 the asset gained in value, if you sold the asset that day, the asset would be valued at $500,000, without the $400,000 in capital gains.
President Biden has proposed eliminating that step-up in basis, which could mean much higher tax bills for people who inherit wealth.
If the president’s proposals are passed into law, you could end up paying upwards of 50 percent in capital gains taxes if you live in California.
Reardon Law Firm is here to help
Does this sound confusing? It certainly can be, and you can’t be expected to keep up with every new tax law that develops. That’s what estate planning attorneys are for. Contact Reardon Law Firm today for a consultation.