Capital Gains & Dividends
- How does the tax treatment of capital gains and dividends differ from the tax treatment of income from work?
- What are the consequences of the tax-favored treatment of capital gains and dividends?
- Who benefited from the 2003 tax cut for capital gains and dividends?
- Where things stand on the Hill
- Information & resources
How does the tax treatment of capital gains and dividends differ from the tax treatment of income from work?
Under the current tax code, income from work is taxed at higher rates than investment income from capital gains and dividends. Income from work — including wages, salaries, tips, overtime pay, commissions, bonuses, business and farm income — is considered "ordinary income" and taxed at rates up to 35 percent. Capital gains (profit from the sale of stock and other capital assets) and dividends (share of profits paid by a qualified foreign or domestic corporation) are taxed at a maximum rate of 15 percent. In addition, income from work is subject to federal employment taxes for Social Security (12.4 percent on earnings up to $97,500 in 2007, including the employer and employee share) and Medicare (2.9 percent on all earnings, including the employer and employee share). Capital gains and dividends income are not subject to federal employment taxes.
What are the consequences of the tax-favored treatment of capital gains and dividends?
Because most of the assets that generate capital gains and dividends income are owned by the very wealthy, the tax-favored treatment of investment income means that the very, very wealthy may pay a lower tax rate on their income than average working Americans. As Warren Buffett observed, he paid a lower tax rate on the $46 million he made last year than his secretary paid on her $60,000 salary. The lower tax rate on capital gains also creates an incentive for wealthy taxpayers, such as private equity and hedge fund managers, to devise ways to make income from work like capital gains. Capital gains have not always received tax-favored treatment; the 1986 Tax Reform Act, signed by President Ronald Reagan, taxed capital gains and income from work at the same rates.
Who benefited from the 2003 tax cut for capital gains and dividends?
The 2003 tax cuts reduced the tax rate on capital gains and dividends from 20 percent to 15 percent. Data from the IRS show that these tax cuts cost the nation nearly $92 billion in 2005 alone, and three-quarters of the tax cuts went to the wealthiest 0.6 percent. The bottom 97 percent — tax filers with adjusted gross income below $200,000 — got just 12 percent of the benefits. For tax filers with incomes over $10 million in 2005, the tax cut for capital gains and dividends income meant an average tax break of $1,876,280 each.
Where things stand on the Hill
Congress is not currently considering proposals to broadly change the way capital gains and dividends are taxed, although the tax loophole exploited by private equity and hedge fund managers has focused attention on the issue. The special low 15 percent tax rate for capital gains and dividends income expires at the end of 2010.
End the Break on Capital Gains, Urban Institute (July 30, 2007).
New IRS Data Pegs Cost of Special Low Tax Rates on Capital Gains and Dividends at $92 Billion in 2005 Alone: Three Quarters Goes to Richest 0.6%, Citizens for Tax Justice (August 10, 2007).