Capital gains tax
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In many jurisdictions, including the United States and the United Kingdom, a capital gains tax or CGT is charged on capital gains, that is the profit realised on the sale of an asset that was previously purchased at a lower price. The most common capital gains are realized from the sale of stocks, bonds, and property.
United Kingdom
Individuals who are resident or ordinarily resident in the United Kingdom (and trustees of various trusts) are subject to a capital gains tax, with exceptions for, for example, prinicipal private residences, holdings in ISAs or gilts. Every individual has an annual capital gains tax allowance: gains below the allowance are exempt from tax, and capital losses can be set against capital gains in other holdings before taxation. Individuals pay capital gains tax at their highest marginal rate of income tax (0%, 10%, 22% or 40% in the tax year 2004/5) but since 6 April 1998 have been able to claim a taper relief which reduces the amount of a gain that is subject to capital gains tax (reducing the effective rate of tax), depending on whether the asset is a "business asset" or a "non-business asset" and the length of the period of ownership.
A taxpayer is exempt from CGT on his/her principal private residence. Certain other gains are allowed to be rolled over upon re-investment. Investments in some start up enterprises are also exempt from CGT. The sale of a family business can be exempt from CGT upon retirement.
Companies are subject to corporation tax on their "chargeable gains" (the amounts of which are calculated along the lines of capital gains tax). Companies cannot claim taper relief, but can claim an indexation allowance to offset the effect of inflation. A corporate "substantial shareholding exemption" was introduced on 1 April 2002 for holdings of 10% or more of the shares in another company (30% or more for shares held by a life assurance company's long-term insurance fund). This is effectively a form of UK participation exemption. Almost all of the corporation tax raised on chargeable gains is paid by life assurance companies taxed on the I minus E basis.
United States
In the United States, individuals and corporations pay income tax on the net total of all their capital gains just as they do on other sorts of income, but the tax rate is lower for "long-term capital gains", which are gains on assets that had been held for over one year before being sold. The tax rate on long-term gains was reduced in 2003 to 15%, or to 5% for individuals in the lowest two income tax brackets. Short-term capital gains are taxed at a higher rate: the ordinary income tax rate. In 2013 these reduced tax rates will "sunset", or revert back to the rates in effect before 2003, which were generally 20%.
Technically, a "cost basis" is used, rather than the simple purchase price, to determine the taxable amount of the gain. The cost basis is the original purchase price, adjusted for various things including additional improvements or investments, taxes paid on dividends, certain fees, and depreciation.
Exemptions from capital gains taxes (CGT) in the United States include:
- Every two years, an individual can exclude up to $250,000 ($500,000 for a married couple) of gains on the sale of their primary residence.
- If an individual or corporation realizes both capital gains and capital losses in the same year, the losses cancel out the gains in the calculation of taxable gains. For this reason, toward the end of each calendar year, there is a tendency for many investors to sell their investments that have lost value. For individuals, if losses exceed gains in a year, the losses can be claimed as a tax deduction against ordinary income, up to $3,000 per year.
