Tax Savings through Highest Tax Rate: Federal Tax Rate Analysis

In the previous episode, we introduced what active income, passive income, and self-employment taxes are, and we discussed how Social Security has an upper limit. Today, let’s take a closer look at federal taxes.

Federal Tax Calculation: Active Income, Passive Income, Short-Term Capital Gains

For active income, after paying employment taxes, the remaining amount is subject to federal taxes. In the case of passive income, money earned is also subject to federal taxes. If it involves selling assets, we categorize it into short-term capital gains (held for less than 1 year) and long-term capital gains (held for more than 1 year). The calculation for short-term capital gains is the same as for ordinary income. Ordinary income is further divided into categories such as married, single, and head of household. Today, we will mainly focus on calculating taxes for married couples. Before delving into the details, it’s crucial to remember that not all income is taxed at the same rate but follows a progressive tax rate. For example, within the income range of $0 to $23,200, the taxable income is subject to a 10% tax rate. Beyond $23,201 to $94,300, the tax rate is 12%, and for the portion exceeding $94,300 to $201,050, the tax rate increases to 22%. As you can see, the tax rate progressively increases as income increases. In 2024, for married couples, income exceeding $731,000 is taxed at a rate of 37%. Whether it’s your active income, passive income, or short-term capital gains, the calculation goes as follows.

Other Calculation: Long-Term Capital Gains

For long-term capital gains, the United States encourages individuals not to sell their assets hastily and advocates a “buy and hold” approach. If you sell any asset after holding it for more than one year, it qualifies for a lower tax rate. For amounts up to approximately $94,000 or less, long-term capital gains are actually not subject to taxation. From around $94,000 to $583,000, a 15% tax rate applies, and for amounts exceeding $583,000, a 20% tax rate is applicable.

Therefore, based on this scenario, when income is high, any tax-reducing measures, deductions, or retirement plans undertaken serve to reduce the portion taxed at the highest rate. For example, if Mr. and Mrs. Chang earned $900,000 this year, and we implemented a tax reduction plan saving them $150,000, about 37% on the federal tax. Of course, it’s important not to forget about state taxes.

California does not have a long-term capital gains tax rate, and the taxes can be astonishing!

If you reside in California, it’s important to note that California does not have a separate long-term capital gains tax; it follows federal taxation rules. Therefore, if you sell stocks or property, don’t assume that the federal long-term capital gains tax is only 20%—that’s incorrect! In California, since there’s no separate long-term capital gains tax, it is subject to regular income tax rates, which can go up to 14.4%. And that’s not all; if your income exceeds $250,000, you’ll also have to pay an additional 3.8% for the Obamacare tax. Long-term capital gains in California can be taxed up to 38.2%. So, considering these examples, it is important for you to save on taxes!

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This article is for informational purposes only and should not be construed as financial advice or legal advice. Please consult with a professional to develop a strategy that is right for you. Investing in securities involves risks, and there is always the potential of losing money when you invest in securities. TransGlobal Advisory, LLC (TGA) does not provide legal, tax, or accounting advice. You should consult your personal tax or legal advisor before making any financial decisions.