Question

Mr. and Mrs. Poe earned $115,900 compensation income and $963 interest this year and recognized a $600 short-term capital gain and a $7,200 long-term capital gain on the sale of securities. They incurred $4,400 investment interest expense and $25,500 other itemized deductions. Use Individual tax rate schedules and Tax rates for capital gains and qualified dividends.

1. Compute the Poe’s income tax on a joint return if they don’t elect to treat long-term capital gain as investment income.
2. Compute the Poe’s income tax if they elect to treat enough long-term capital gain as investment income to allow them to deduct their investment interest.

Answer 1

Taxpayers can elect to include qualified dividends and net capital gains in the calculation of net investment income for the year for the purpose of deducting investment interest. This election is accomplished by choosing how much of your qualified dividends and net capital gains you want to include in net investment income on line 4(g) of Form 4952.

The effect of this election is that qualified dividends and net capital gains included in net investment income are taxed at ordinary tax rates, not at the lower long-term capital gains tax rates. But another effect of this election is that you could have higher net investment income and thus a higher deduction for investment interest.

2019 Tax Brackets (Due July, 15 2020)
Tax rate	Single filers	Married filing jointly*
10%	$0 – $9,700	$0 – $19,400
12%	$9,701 – $39,475	$19,401 – $78,950
22%	$39,476 – $84,200	$78,951 – $168,400

Now as we can see Mr. & Mrs. Poe are filing jointly, tax rate applicable to them is 22%.

	If Long-term capital gain is treated as
	Investment Income	LTCG
Compensastion	$                         1,15,900	$                             1,15,900
+Interest Income	$                                   963	$                                       963
+Short-term Capital Gain	$                                   600	$                                       600
	$                         1,17,463	$                             1,17,463
Itemized Deduction	$                           -25,500	$                               -29,900
Net Income	$                             91,963	$                                 87,563
Tax @ 22%   (a)	$                             20,232	$                           19,263.86
Longterm Capital Gain	$                               2,800	$                                   7,200
Tax @ 15%   (b)	$                                   420	$                                   1,080
Total Income Tax    (a+b)	$                       20,651.86	$                           20,343.86

Therefore it is better to not settle longterm capital gain against investment interest expense.