1) The tax law provides preferential rates to long-term capital gains to incentivize taxpayers to make investments which promote economic growth (Spilker, et al., 2021).

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1) The tax law provides preferential rates to long-term capital gains to incentivize taxpayers to make investments which promote economic growth (Spilker, et al., 2021). Long-term capital assets are those sold more than a year after obtained, while short-term capital assets are those sold less than a year after obtained (Spilker, et al., 2021). However, tax law only provides preferential rates for gains from long-term capital assets, while gains from short-term capital assets are taxed at ordinary rates (Spilker, et al., 2021). Investors of long-term capital assets assume greater risk in their investment (Spilker, et al., 2021), so the preferential tax rates help incentivize investors to make those investments that stimulate economic growth, despite the risk.

Taxpayers investing in capital assets can use the tax planning strategies of long-term holding of capital assets, loss harvesting, and the specific identification method for determining tax basis. Holding capital assets for longer than one year creates long-term assets, which are subject to preferential tax rates and gain deferrals until the asset’s sale or disposition (Spilker, et al., 2021). These benefits yield greater after-tax rates of return for investments than are yielded by assets not subject to these benefits (Spilker, et al., 2021). Loss-harvesting involves selectively selling certain assets at a loss (those not expected to yield greater economic benefit through holding), allowing taxpayers to deduct up to $3,000 from their ordinary income and decrease their total yearly taxable capital gains (Spilker, et al., 2021). However, taxpayers must be mindful to avoid the wash-sale rule when selling assets for loss-harvesting (Spilker, et al., 2021). By using the specific identification method for determining tax basis, taxpayers minimize the present value of taxes paid by choosing to sell high tax basis stock first, effectively minimizing gains or decreasing losses on their return (Spilker, et al., 2021).

Reference List:

Spilker, B. C., Ayers, B. C., Lewis, T. K., Weaver, C. D., Barrick, J. A., Robinson, J. R., Worsham, R.G. (2021). McGraw-Hill’s taxation of individuals and business entities. New York, NY: McGraw Hill LLC. 

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2)

. Why does the tax law provide preferential rates on certain capital gains?  

In chapter seven of our textbook, we learned that the tax law provides preferential rates on certain capital gains because it provides an incentive for the taxpayers to invest their money in different assets that could help stimulate the economy of the state. Long term capital gains are taxed at preferential rates. When the taxpayers sell capital assets after they hold the asset for more than a year recognize long-term capital losses or gains. But long term capital gains are not created equally. Most of the long-term capital gains are taxed at zero percent, 15 percent, or twenty percent. The tax rate depends on the filing status and taxable income of the taxpayers.

Describe three basic tax planning strategies available to taxpayers investing in capital assets. 

The three tax planning strategies for taxpayers investing in capital assets are the following:

First is holding capital assets for more than one year. When the taxpayers invest in an asset for more than one year, they get at least two benefits. First is that they can defer recognizing gains on the assets until they sell those assets. The present value of the capital gains gets lower with the longer deferral period, at the time when the taxpayer finally decides to sell it. The second benefit is that they pay taxes on gains at preferential rates.

The second strategy is loss harvesting. When the taxpayers invest in capital assets, there is a risk that some of their investments may decline in value. Loss harvesting is a productive strategy for managing investments in capital assets by selling investments with built-in losses. Selective selling of the loss assets can help the taxpayers reduce their tax deductions for up to 3,000 Dollars against their ordinary income and by reducing the number of capital gains that would otherwise be subject to tax during the year.

The third is balancing tax with non-tax factors. The strategy is that tax planning should be done only after the consideration of all relevant parties.

References

Spilker, B., Ayers, B., Outslay, E., Weaver, C., Barrick, J., Robinson, J., & Worsham, R. (2020). McGraw-Hill’s taxation of individuals and business entities (2021th ed). McGraw Hill.

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