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Just like regular income, you must usually pay taxes on capital gains – and often twice. The Internal Revenue Service wants a percentage of your profit, and most states do too. The state tax is in addition to the federal tax, not included in it.
How the Tax Works
A capital gain is any profit you realize when you sell an asset for more than what you paid for it. You can add some costs associated with the purchase to the price, such as commissions you must pay when you buy stocks or real estate. If someone gives you an asset and you later sell it, its tax basis is what the original owner paid. If you inherit an asset, its purchase price "steps up" to what it was worth on the date the former owner died.
Federal Tax Rates
The federal capital gains tax changed marginally with the passage of the fiscal cliff deal in January 2013. If you're married and don't earn more than $450,000 a year, or $400,000 if you're single, the rate is unchanged – it's still 15 percent. If you earn more than that, however, the rate hikes to 20 percent. These rates are for long-term capital gains; they apply when you hold ownership of an asset for a year or more.
While most states impose capital gains tax, some do not. Those that don't include Wyoming, Texas, South Dakota, Nevada, Alaska, Florida, New Hampshire, Tennessee and Washington. In you live in one of the other 41 states or the District of Columbia, capital gains tax rates range from a low of 2.5 percent in New Mexico to a significant 13.3 percent in California. These rates are in addition to the federal rate.
Another add-on is the 3.8 percent investment tax that Congress implemented to help fund the Affordable Care Act, also known as Obamacare. This is in addition to any state capital gains tax you owe and the federal capital gains tax. It’s a secondary federal levy on income derived from royalties, dividends, interest, rents, annuities – and capital gains. Therefore, you'll pay the IRS on your capital gains twice. Married individuals with modified adjusted gross incomes of more than $250,000 a year – $200,000 if you’re single – have the option of paying this tax on the difference between these thresholds and their MAGI, or they can simply pay 3.8 percent on the total of their investment earnings, whichever is less.
Adding it All Up
When you add up all three taxes, your tax burden can be considerable: 18.8 percent or 23.8 percent at the federal level, depending on your income – even if you live in one of the nine states that does not impose its own capital gains tax. If you live a state with one of the highest capital gains rates, you could pay more than 30 percent on the same gain – first to the IRS, then a little more to your state, then the investment tax as well. The states with the highest capital gains tax rates include California, New Jersey, New York, Vermont and Oregon.