CAPITAL GAIN

If you buy a piece of land or a company's stock in January and then sell it the next January for a higher amount, you have realized a capital gain on that asset. (If the value of that land or stock has gone down between the time you bought and sold it you have experienced a capital loss.) Capital gains are controversial because they usually accrue to people in higher-income tax brackets. The reason for this is simply that higher-income people generally have more money to set aside for stock market investments or real estate speculation. However, between 1921, when the federal government first began taxing capital gains, and 1987, capital gains were always taxed at a lower rate than regular income. In other words, while the U.S. government taxes 100 percent of a person's ordinary work income every tax year, it has traditionally taxed only 20 to 40 percent of long-term capital gains (depending in part on your income level and how long you have held the asset). Critics call this unfair. Why should the ordinary income that every working person makes be fully taxed while the capital gains that mostly upper-income people make is only partly taxed?

Defenders of lower tax rates for capital gains usually cite two main reasons. First, capital gains tax rate only applies to that portion of income that is plowed back into the economy in the form of job-creating capital investment. Second, suppose you hold a stock for ten years and in the eleventh year sell it for a capital gain of $50,000. If your capital gain were taxed as ordinary income, your income during that eleventh year would shoot up by $50,000. This would probably put you in a higher income tax bracket and force you to pay much higher taxes on your $50,000 than if you had paid taxes on your stock every year as it was growing. In other words, if you had to pay ordinary taxes on your $50,000 in capital gains you might think twice about selling your stock—and you might even hold onto a stock that had begun to fall in price just to avoid a big tax penalty. During the 1990s, more ordinary Americans than ever before bought stocks (often by investing in mutual funds) and enjoyed capital gains. This made it more politically palatable for Congress to pass the Taxpayer Relief Act of 1997 which lowered the capital gains tax rate to 20 percent for assets held for more than eighteen months.

See also: Asset, Stock

cap·i·tal gain • n. (often capital gains) a profit from the sale of property or of an investment.