Multiple cases.
How would an employee change his income into capital gains?
How would an owner of a business change from income to capital gains?
I suppose you could offer to work for a share of your company rather than be paid a salary. Tell them that instead of getting a paycheck, you’ll work there for the next ten years if they you five percent of the company.
My understanding is you’ll still owe taxes for the value of the five percent at the time you receive it. But if the company expands in value after you get your five percent, than your share of the company will also increase in value. You’ll only owe taxes on the difference between when you received it and when you sold it. And the tax rate will be significantly lower than the income tax rate.
The downside is you won’t be receiving any money until you sell your share. Plus there’s no guarantee that the value will increase.
Well, you have to buy and sell assets to get capital gains if I understand them correctly.
Here’s something to get you started.
Notice where it says you have to wait a year.
So I’m too poor for this to be profitable. Any idea of examples of jobs/people who would be in position to make more profit from this sort of change?
You could start a hedge fund.
Hedge fund managers are compensated with “carried interest” so their income from the fund is taxed as a return on investments as opposed to a salary. The incentive fee is taxed at the long-term capital gains rate
Their have been several attempts to overturn this loophole in Congress. I don’t look for this Congress/President to do so any time. (I was going to say any time soon, but I’ll leave it there.)
The also often incorporate a reinsurance company in Bermuda which then reinvests in the hedge fund. As Bermuda does not have a corporate income tax, none of this is taxed until it’s repatriated. They have to do this as an insurance company to avoid running afoul of the IRS. Even though to qualify as an active business, a reinsurance company cannot have a pool of capital that is too much larger than it needed to back the insurance that it sells, apparently too much larger can mean quite a lot actually.
You don’t have to do this with your entire salary. You can do this for any portion of your salary. You could do half cash and half stock. The value of the stock at the time would be taxable as income but any increase would be taxable as capital gains.
Capital gains are income, just they’re taxed differently than “earned” income … earned income is the money you work for, either with a W-2 or Schedule C; unearned income is the money just given to you, like capital gains or dividend payments … there’s a couple of differences in how these two types of income are taxed: 1] Earned income tax is progressive, make hardly any money and there is no income tax, make a middle amount of money and you’ll pay 17%, make a ton of money and you’ll pay 33% (tax brackets simplified for illustration purposes), unearned income is taxed in a variety of ways, but for this discussion let’s call it a flat 20% (see note below); and 2] Earned income is subject to 15% Social Security taxes, unearned income is not; however SS taxes are capped at around $15,000 per year …
With this information in mind, we can see that if you’re only paying 17% ordinary income taxes, you don’t want to pay the 20% capital gains taxes, even if it were possible to turn earned income into capital gains, which you really can’t anyway … it’s only those of us making enough money to push into the 33% tax bracket that capital gains taxes gives a tax break … now, remembering that SS taxes are capped at $15,000, this is a kinda sorta trivial amount for folks in the 33% tax bracket, all income over $100,000 per year is exempt from SS taxes …
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If I may change the question in the OP a little: “How would an employee change his income into dividend income?” … this can be done and it can be done completely lawfully, to wit:
Form a corporation in Bermuda, hire yourself for $10/hr, have your corporation contract with the employer for $300/hr … your W-4 will show $20,000 income, taxed at 17% + 15% (income tax + SS tax); your 1099-DIV with show $600,000 income, taxed at 20% [ka’ching] and NO SS tax … big tax savings over having to pay 33% + $15,000 SS taxes … there’s a couple of “catches” you’ll have to resolve to keep this scheme legal: 1] The primary purpose for incorporating in Bermuda cannot be for tax savings, you’ll have to dream something up for this incorporation and Bermuda happily has passed laws for which you can avail yourself to, and 2] It’s very very easy to under-report your dividend income and thus pay even less in taxes, that’s terribly illegal and the IRS is watching this like a hawk hunting field mice … don’t get greedy, report ALL your dividend income and be safe.
Again, this is for the wealthy … if you’re only paying 17% in taxes then none of this is worthwild …
Not paying SS taxes means you will not receive any SS benefits … I’ve known a few “clever” people who were mightily surprised on their 67th birthday who are living in cardboard boxes down in TJ right now …
Missed edit window …
Note: Capital gains are taxed at 20%, AND there’s a 4% surtax on capital gains over $250,000 … so sometimes we’ll see this tax rate stated as 24% …
Is the 4% surtax on the amount of capital gains over $250K, or the full amount?
Regards,
Shodan
I am sorry, but no. This is just not the way it works.
The distinction you are trying to make is between capital gains and what is called “ordinary income” – not “earned income” and “unearned income.”
All ordinary income (whether earned or unearned) is subject to the same income tax rate. (Earned income may be subject to other taxes such as FICA.) “Ordinary income” is defined as all income that is not capital gains.
Capital gains are divided into two classes: short term and long term. Net short term capital gains are taxed at the same rates as ordinary income. Net long term capital gains are always taxed at a lower rate than if they had been ordinary income.
Long term capital gains are taxed at 3 different rates: 0%, 15%, and 20%. The rates are determined by what they would have been taxed at if they had been ordinary income. If, as ordinary income, the LT capital gains would have been taxes at 10 or 15%, they are instead taxed at 0%. If, as ordinary income, they would have been taxed at 25% through 35%, they are taxed at 15%. If they would have been taxed at 39.6%, they are instead taxed at 20%. It is always better to have long term capital gains, but you do not have that choice.
It would be on the whole amount, but it’s a little more complicated than that. If your modified adjusted gross income (MAGI) is below the threshold ($200K for single, $250K for married filing jointly), it doesn’t kick in. If you are above that, then it’s the lower amount of difference between MAGI and threshold or net investment income.
Keep in mind these rates aren’t automatic. They only apply to people who are in the top rate for income tax. So if your annual income is below $418,400 you’ll pay a 15% capital gains rate instead of 20%. And if your annual income is below $37,950 your capital gains rate is zero.
It’s actually 3.8%. It only applies to the amount above $250,000 (or $200,000 if you’re filing as single).
Correct.
And just to clarify, it’s called the “Net Investment Income Tax” and is not specifically a tax on capital gains or a tax on “unearned income.” It does include capital gains and a complex list of other investments.
Thank you for all these corrections to my statements … my only excuse was I was trying to keep things simple … with grossly simplified examples … y’all are perfectly correct and I apologize for the misleading statements I made …
I went through the instructions for this earlier this year … what a fucking maze …
I think my point still stands … capital gains tax is a major tax break for the rich … for those of us with low or middle incomes, it’s not worth the cost of a CPA to work it all out …
An example - more relevant to businesses - is the hotel industry. For a while, it seems each hotel building was a different brand every 5 or 10 years. My understanding was that the hotel chains would buy a building, use the proceeds to pay the mortgage (deduct mortgage interest and depreciation), then sell the building once paid off. The profit is capital gains.
You could, I suppose, do the same with rental properties. You use your surplus money to buy property, the renters help pay the mortgage, assorted costs and losses are deductible from taxes. Then at the end, sell it off and pay capital gains on the appreciated value.
So don’t use one. I had capital gains even back when I was earning seven and change an hour. Schedule D and Form 8949 are pretty straightforward.
Thanks.
Regards,
Shodan
Do Americans pay what we call benefit in kind taxes? For example - If your employer owns a house and lets you live rent-free; or if they pay your kids’ college fees, would you have the value of those benefits added to income?
Over here, this principle has been extended as far as parking spaces and free beverages in some cases.
What he meant was using a shell corp to turn what’s really W-2 wages into income treated as capital gains. He wasn’t talking about reporting the capital gains one has on more typical stock market investments.
Yes. In US tax parlance it’s called “imputed income.” It’s not as heavily policed as it could be, so there are lots of mid-sized businesses that manage to do a lot of stuff for their owners’ benefit that ends up as a deductible expense to the business but somehow is not shown as income to the owner.
In my industry it’s common that any free or very-reduced-cost travel benefits you use each year show up on your annual earnings tax statement (“W-2” in the argot) as imputed income for the difference between what you did pay and some higher-but-still-low artificial ticket price. Company provided life insurance above a certain threshold is another common example of imputed income.
One glaring exception is health insurance. By law neither the premiums the company pays on your behalf nor the value you receive are considered as income.