Take Advantage of 0% Cap Gains Before It's Too Late

This happy state of affairs will continue through 2010 unless Congress changes the rules, which could easily happen if the Democrats seize full control in Washington. That means you should make every effort to take advantage of the 0% rate this year. Wait until next year and it just might be too late.

Here's how it works.

Say you file jointly, have two dependent kids and claim the standard deduction for 2008. You could report up to $90,000 of adjusted gross income this year (including long-term capital gains and dividends) and still be within the 15% rate bracket. Your taxable income would be $65,100, which is the top of the 15% bracket for joint filers.

Say you're divorced, use head of household filing status, have two dependent children, and claim the standard deduction for 2008. You could have up to $62,150 of adjusted gross income this year (including long-term capital gains and dividends) and still be within the 15% rate bracket. Your taxable income would be $43,650, which is the top of the 15% bracket for heads of households.

Say you're single with no kids and claim the standard deduction for 2008. You could have up to $41,500 of adjusted gross income (including long-term capital gains and dividends) and still be within the 15% rate bracket. Your taxable income would be $32,550, which is the top of the 15% bracket for singles.

If you itemize deductions, your adjusted gross income (including long-term capital gains and dividends) could be even higher, and you could still be within the 15% rate bracket.

Remember: The adjusted gross income figures I'm quoting are after subtracting any write-offs allowed on page 1 of your 2008 Form 1040 (these are the so-called above-the-line deductions). Among others, these write-offs include deductible retirement account contributions, health savings account (HSA) contributions, self-employed health-insurance premium costs, alimony payments, moving expenses and more. If you have some above-the-line deductions, your income can be that much higher, and you'll still be within the 15% rate bracket.

More often than not, the parent's rate will be higher. Their marginal federal rate on 2008 ordinary income, such as short-term capital gains and interest, can be as high as 35%. The rate on their long-term capital gains and dividend income is probably 15%. Meanwhile, the child's rate on ordinary income is only 10% or 15% and their long-term capital gains and dividends will be taxed at the aforementioned 0% rate.

Fortunately, the Kiddie Tax for 2008 will only be an issue when all four of the following requirements are met:

Requirement 1: One or both of the child's parents are alive as of Dec. 31, 2008, and in a higher marginal federal income tax bracket than the child or grandchild.

Requirement 2: The child doesn't file a joint return for 2008.

Requirement 3: The child's unearned income exceeds $1,800 — the limit for 2008 — and she has positive taxable income after subtracting applicable deductions (such as the standard deduction). If the threshold is not exceeded, the Kiddie Tax doesn't apply for 2008. If the threshold is exceeded, only unearned income in excess of $1,800 will be hit with the Kiddie Tax.

Requirement 4: The child or grandchild falls under one of the three age rules explained below.

Age Rule No. 1 (Under age 18 at year-end): If the child is younger than 18 at the end of 2008, the Kiddie Tax will apply if the other three requirements are met for the year. It makes no difference whether or not the child or grandchild is claimed as a dependent on your return (or on anyone else's for that matter).

Age Rule No. 2 (Age 18 at year-end): If the child is age 18 come Dec. 31, 2008, and his earned income doesn't exceed half of his support, then the Kiddie Tax will apply if the other three requirements are also met for the year. Again, it makes no difference whether or not the child is claimed as a dependent on your return (or on anyone else's).

Age Rule No. 3 (Age 19-23 at year-end and a student): If the child is between the ages of 19 and 23 at the end of the year, and: (1) is a student for 2008, and (2) doesn't have earned income that exceeds half of her support, the Kiddie Tax will apply if the other three requirements are also met for 2008. It makes no difference whether or not the child is claimed as a dependent on your return (or on anyone else's return). Your child or grandchild is considered to be a student if she attends school full-time for at least five months during 2008.