Carrie Schwab Pomerantz
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Dear Carrie: If a family makes less than $68,000 a year, aren't they exempt from the capital gains tax? -- A Reader

Dear Reader: With all the political discussion surrounding last December's legislation extending tax cuts, a lot of people find themselves confused on just what this means for them, particularly in terms of capital gains taxes. So, thanks for your question.

Since 2008, investors have been enjoying more favorable long-term capital gains tax rates: zero percent for investors in the 15 percent or lower tax bracket; 15 percent for those in the 25 percent tax bracket or higher. These rates were scheduled to go up after the end of 2010, but new legislation extended them for another two years, through 2012. For the record, long-term capital gains rates apply to profits made on investments held for more than one year. (Profits on investments held for one year or less are taxed as ordinary income.)

Long-term capital gains are added to regular income to determine if the zero percent rate applies. For tax year 2010, that means single taxpayers will pay tax at a 0 percent rate for long-term capital gains that fall into the income range of $34,000 or less ($68,00 for married taxpayers filing jointly). Long-term capital gain income added over those thresholds is taxed at the higher rate. These taxable income levels go up to $34,500 and $69,000 respectively in 2011.

That all seems pretty straightforward. But the confusion can come in how the capital gains you realize affect your taxable income. I'll try to clarify a bit.

FACTORING YOUR CAPITAL GAINS INTO YOUR TAXABLE INCOME

Your question concerns a family making less than $68,000 a year. And while you're correct that $68,000 is the highest 2010 income level in the 15 percent tax bracket for married filing jointly, it's your taxable income -- not just how much you make -- that determines what tax bracket you fall into.

Your taxable income is your total gross income minus allowable personal exemptions and deductions. Gross income includes both earned income (salary, wages, tips, commissions, bonuses, unemployment benefits and sick pay) and unearned income dividends, interest, and the profit you make when you sell an investment -- your capital gain).

So if you actually make $68,000 a year, and then sell some long-term investments at a profit, you have to add your capital gains earnings to that total. You'd then subtract your exemptions and deductions to arrive at your taxable income. For 2010, if you come in under $68,000, you wouldn't have to pay capital gains taxes. Any amount over that threshold would be taxed at the higher rate.

ADDING IN STATE TAXES

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Carrie Schwab Pomerantz

Carrie Schwab Pomerantz is a Motley Fool contributor.

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