Published December 2003

Take advantage of the cut
in capital gains tax

By now, you’re probably familiar with some elements of the Tax Relief Act of 2003. If you have children at home, you’ve likely received your child tax credit “bonus’’ payments. And you may have seen your take-home pay increase in response to cuts in marginal tax rates. But there’s another key area of the new legislation that you may have yet to explore — the cut in the capital gains tax rate.

Here’s how it works: If you’re in a tax bracket of 25 percent or higher, you only will have to pay a capital gains rate of 15 percent (down from 20 percent) on the sale of stocks, mutual funds or some other types of assets you’ve held for at least a year.

This cut could have major implications for your investment strategies. You can now sell appreciated stocks or mutual funds and incur a lesser “tax hit.” But why would you want to sell in the first place?

Like all investors, you need to periodically adjust your portfolio to make sure it contains the mix of investments that’s suitable for your individual goals and risk tolerance.

Over time, you may decide that some of your stocks, for example, no longer suit your needs. Why? Maybe the management team has changed a company’s direction. Or maybe that company belongs to an industry whose long-term prospects now look poor. Or maybe you’re “overweighted” in a particular stock and need to rebalance your portfolio to reduce that specific risk. (Rebalancing your portfolio may have transaction costs or commissions associated with doing so.)

No matter what your reason for selling a stock, though, from a tax standpoint you’ll now find it more affordable. But the capital gains rate cut isn’t just beneficial if you decide to sell stocks. It’s also good news if you’re giving them away.

For example, if you gift appreciated stocks to your grown children, they will ultimately have to pay capital gains taxes based on the total growth achieved from the time you bought the stock. Now, with the lower capital gains taxes, they won’t face such a hefty cost.

But you might also want to give appreciated stocks to younger children, especially those who are over age 13 and are exempt from the “kiddie tax’’ rules (which stipulate that investment income over $1,500 will be taxed to them at your individual tax rate).

In fact, the new capital gains laws present you with a particularly unusual opportunity: If you give appreciated stocks today to a child over 13, the child can sell the stocks in 2008 and pay no capital gains taxes, assuming the child is in the 10 percent or 15 percent tax bracket.

Normally, anyone in those brackets will only have to pay a 5 percent long-term capital gains rate, but in 2008 only, this rate drops to zero. This special tax break can result in an excellent source of funding for a time-sensitive goal, such as college.

Clearly, the cut in capital gains taxes can provide you with some significant benefits, along with some strategic and bookkeeping challenges. If you sold some stocks before May 6, when the new laws went into effect, your capital gains will still be taxed at the old rate, most likely 20 percent. That’s why you might want to consider selling some “losers’’ to counter the gains that were taxed at the higher rate.

See your tax and financial advisers before making any important capital gains-related moves. And take the time to explore all the opportunities the new tax laws have now made possible for you. Doing so may be well worth your effort.

Eric Cumley is an investment representative with Edward Jones Investments at 1201-C SE Everett Mall Way in Everett. He can be reached at 425-353-2322. Edward Jones is an NYSE-member investment firm with more than 8,000 locations nationwide.

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