Federal Tax, Capital Gains - What Is Their Relationship

December 7, 2004
By Srinidhi Goenka

The federal income tax is a tax which is levied on the taxable income of the citizens of a country for a taxable year. It is also charged to estates, trusts, partnerships, corporation and other business entities. Also, there is a correlation between federal tax and capital gains.

The federal tax affects capital gain calculations. It helps to determine the tax bracket or rate which is applied while calculating the capital gains tax amount. If you have made some short term gains, then this could affect your federal tax amount.

This gain might move you to a higher income bracket, wherein your short term gain will be charged at a higher rate in comparison to your original/previous tax rates.

Higher The Federal Income, Higher The Capital Gains Tax

Let us assume that you are an individual tax payer and your taxable income is $34,400. according to this income, you are liable to pay 15% tax as per the rules of your country. Now you make a short term capital gain of $500.00, so your total taxable income now becomes $34,900.

Now, according to the slab rates, the limitation of the federal tax at the rate of 15% is $34,499.00. Since you have made an additional capital gain of $500, the next federal tax rate is 27.5%.

So, your capital gains tax will be calculated in the following manner :

Income upto $34,499 = $34,499 - $34,000 = $499 @ 15% = $14.85
$401.00 @ 27.5% = $110.275
Total capital gains tax payable = $125.00

Please note that all the tax rates and figures in the above example are hypothetical and not based on actual tax rates or slabs.

Thus we can see how your federal income affects the capital gains tax rate. Basically, the capital gains tax is a part of the federal tax in a broader sense. This is the reason why people with a high federal income also have to pay a higher capital gains tax, since they keep on moving into higher tax brackets.