Don't Mess With Taxes

Plus, a look at what next year’s inflation bumps mean to estate planning, gifts you give before you go, youngsters' investment earnings, and more.

Leonardo DiCaprio in "The Great Gatsby," the 2018 movie version of F. Scott Fitzgerald's novel. (Warner Brothers Pictures promotional photo)

“Let me tell you about the very rich. They are different from you and me.”

F. Scott Fitzgerald didn’t add taxes in his elaboration of those differences in his 1925 short story “The Rich Boy,” but he could have.

While most of us middle-income taxpayers get our money working for wages, wealthier individuals tend to let their money work for them as investments. And when they cash out long-term assets, the tax rate on the profits is typically much lower.

A holding is long-term if it's owned for more than a year. At that point, it qualifies for the long-term capital gains tax rate. For those in the top ordinary tax rate of 37 percent levied on ordinary income, the capital gains maximum  is a substantially lower 20 percent.

Money-making assets sold before reaching the long-term mark produce short-term capital gains. Those amounts are taxed at the owner's ordinary tax rate. Again, that could be as high as 37 percent. So patience in investing, when possible, can make a big tax difference.

Ordinary and capital gains taxes also share another thing. The amounts that fall into the seven ordinary and three capital gains tax brackets are indexed each year for inflation.

This post, Part 5 of the ol' blog's annual 10-part tax inflation series, looks at those capital gains tax bracket changes.

It also examines other tax matters that generally apply to wealthier taxpayers who have more discretionary income. That includes how much of that wealth they can pass along to heirs without triggering the federal estate tax, as well as the amount in gifts they can hand out tax-free while they’re still around to get the thanks. And youngsters getting an early start in unearned income efforts can shield more of their investment dollars from federal taxation.

Since time is money, let's get started on what the 2025 wealth-related inflation adjustments mean.

Lesser tax bite for capital gains: As noted earlier, since richer people have more discretionary income, they tend to invest substantial chunks of that money. That approach essentially provides a nice income stream.

In addition, when the investments are long-term, again they are held for more than a year, the profit they produce is taxed at a lower rate. The top tax rates on those proceeds are 0 percent, 15 percent, and 20 percent.

Which capital gains tax rate applies depends on your overall income and filing status.

Thanks to changes made by 2017's Tax Cuts and Jobs Act (TCJA), there are separate income brackets for the three capital gains tax rates. The earnings to which the three long-term capital gains tax rates will apply in 2025 are shown in the table below:

   
For comparison, and to use where you're figuring your 2024 taxes when you file next year, here are this year's long-term capital gains rates and income brackets:

    
In addition to capital gains tax rates listed in the tables, higher-income taxpayers may also have to pay an additional 3.8% net investment income tax.

And yes, there are other capital gains tax rates for other holdings, like collectibles, but they aren’t affected by inflation.

Capital gains tax on estates: Uncle Sam also collects capital gains taxes on estates and trusts.

For 2025, the maximum zero capital gains tax rate applies to estates or trusts worth up to $3,250. The top earnings level for an estate or trust to be taxed at 15 percent is $15,900. The 20 percent rate applies to these entities worth $15,901 or more.

For comparison, in 2024 the maximum zero capital gains tax rate applies to estates or trusts worth up to $3,150. The top earnings level for an estate or trust to be taxed at 15 percent is $15,450. The 20 percent rate applies to these entities worth $15,451 or more.

Estate and trust tax rates: There's also a tax, with its own rate schedule, on earnings from trusts and estates. This applies to income that trustees choose to retain rather than distribute to beneficiaries.

Under this system, higher rates kick in at lower income levels than the tax rates and income brackets for individual taxpayers. The design was intentional to keep trusts from being used as tax shelters.

However, the TCJA lowered tax rates for trusts and estates, just like it did for individuals, at least through 2025. It also reduced the number of trust and estate tax brackets from five to four.

The estate and trust tax rates for 2024 and 2025 are shown in the table below.

   
Estate tax exemption increase: Thanks to your investments over the years, you've been able to fulfill the goal of providing for your family here and now. You've also accumulated enough to be able to leave a generous amount to your heirs.

The good news for most of us is that we won't have to worry about the federal estate tax. A portion of what you leave is free from taxation by Uncle Sam, and that generally covers most U.S taxpayers.

The TCJA expanded the estate tax exemption amount even more, and it also is adjusted for inflation.

For 2025, the inflation adjustment means an individual can leave heirs a tax-free estate of up to $13.99 million. That's per person, so a married couple can protect $27.98 million from estate taxation.

That's an increase from 2024's nontaxable estate assets level of $13.61 million per person, and $27.22 million for married couples.

When an estate exceeds those tax-year amounts, then and only then is the federal estate tax, which can go as high as 40 percent, assessed on the overage.

Obviously, these ever-increasing (at least until the TCJA expires at the end of 2025 or is changed before then) multimillion-dollar exclusion amounts mean that the hubby and I — and our families and our friends — likely will never have to worry about the federal estate tax … unless we win the lottery!

Note, though, that you might have to worry about the state tax collector. A dozen states and the District of Columbia still have either an estate or inheritance tax — our old Maryland stomping grounds has both — and their exclusion levels are much, much lower than the federal level.

Tax-free gifting, too: Sometimes people want to share their wealth while they are still around to get the thanks for their generosity.

Not only is that a heartwarming move, it could be tax smart. Giving away some of your assets could help keep your eventual estate out of Uncle Sam's hands when death and taxes finally converge.

The tax code allows you to give a specific amount, known as an annual exclusion, in gifts to others. This will help reduce your estate's value and there's no tax ramifications for the gift recipients.

For 2025, that exclusion amount is $19,000 per person. That's a grand more than the $18,000 you can give away for the 2024 tax year. Remember, Christmas isn't that far away!

Like the estate tax exemption, the gift exclusion limits each year are per person. That means if you're married, you and your spouse each can give a combined $38,000 to the same person in 2025, up from the $36,000 amount for married couples in 2024.

Pulling out my handy calculator, that also means that a married couple with three kids and five grandchildren can each give those eight family members a combined gift total of $304,000 in 2025. That's up from the $288,000 in 2024 without facing gift tax consequences.

And despite my example, you (and your spouse) also can give these gifts to folks beyond your family. That's right. There's no familial relationship requirement. So if you have some spare cash and really enjoy the ol' blog, just let me know.

Also, the gifts are not limited to dollars. You can give assets valued up to the limit, such as gifts of real property and family heirlooms.

By bestowing your cash and property beforehand, you can reduce the amount of your assets left to be distributed after you're gone. This is a good way to dole out your estate the way you want and keep its value under the amount that will trigger the federal estate tax.

Even better, as long as you follow the rules, you won't face any gift tax.

Best of all, for those on your list, your gifts are not taxable to the recipients.

Adding up all those gifts: The major tax-related gifting rule is, of course, that you can't just give away all your riches to escape the tax collector. That's why the lifetime gift exemption, aka the unified credit against the estate tax, was created.

As the name indicates, the lifetime gift exemption is the total amount of gifts that can be given away tax-free by a person over his or her lifetime to any number of people.

It's easy to keep track of because it's the same as the annual estate tax exemption amount. Again, thanks to inflation that's $13.99 million (or $27.98 million per married couple) in 2025. For 2024, it's $13.61 million (or $27.22 per married couple).

If you do go over the lifetime gift exclusion, you will owe a 40 percent tax on those excessive gifts.

Counting the kiddie tax: One of the best gifts parents can give their children is financial education. In many cases, this includes investment accounts in the youngsters' names so they can see first-hand how the system works, or sometimes doesn't.

Often the accounts are opened with monetary gifts, which as noted earlier can be useful tax planning for the givers.

Investments and their earnings have some additional tax considerations for young market mavens. When young people — up to age 23 if a full-time student or 18 if not going to college — have unearned income, generally from dividends and interest or distributed capital gains, that exceed certain limits, the kiddie tax comes into play.

The kiddie tax first appeared in 1986 as a legislative way to close a tax loophole for the wealthy. After a certain earnings level, a child's investment income was taxed at the same rate as that of their parents. By effectively raising the potential tax on the youngsters' passive income, the idea was that well-to-do adults wouldn't be so inclined to shift their wealth by putting it in their lower-taxed children's names.

So what's the earnings amount today that triggers the kiddie tax?

For 2025, a young investor's first $1,350 of unearned income is not taxable. That's a slight increase from the first $1,300 of unearned income that's not taxable in 2024.

Then the next $1,350 in unearned income in 2025 ($1,300 in 2024) is taxed at the child's tax rate, typically the lowest 10 percent rate.

Only when a child's investment earnings top the combined limit — $2,700 in 2025 (the untaxed $1,350 and the next $1,350 taxed at the child's rate) and $2,600 in 2024 — is the young financier's excess unearned income is taxed at higher rates that typically apply to their parents' taxes.

Parents can opt to include a child's gross income in the adults' gross income and calculate the kiddie tax there. One of the requirements for this parental election is that a child's gross income for 2025 must be more than $1,350 but less than $13,500. For 2024 taxes, the child's earnings range is more than $1,300 but less than $13,000.

More inflation tax info on the way: Good news. This Part 5 look at taxes that generally affect wealthy taxpayers means we're half-way through this year's annual 10-part 2025 tax inflation series.

Or if you're a voracious tax geek and see that as bad news, then the good news for you is that there are five more 2025 tax-related inflation posts to come. 

As the box below notes, you can find a directory in the series' first post, along with links to already published inflation adjustments. And for those who want more, the listing also is preview of what's still to come.

Thanks for reading. And thanks especially for your tax inflation interest and explanation patience!

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