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6 Creative Strategies to Reduce or Eliminate Capital Gains Tax on Equity Compensation

6 Creative Strategies to Reduce or Eliminate Capital Gains Tax on Equity Compensation

June 03, 2024

Did you know you can legally postpone or avoid capital gains tax from selling your equity compensation? At some point, you’re bound to sell your appreciated shares, vested restricted stock/RSU, or ESPP for profit.

While you can capitalize on tax relief from securities held over one year, there is an even better solution than favorable capital gains tax rates. Regardless of your reason for selling, the US tax code has legal provisions for tax-free or tax-deferred grant benefits. Here are six ways under the tax code, called tax expenditures, that you can leverage to avoid or defer your capital gains tax.

Stay Within The 10%- and 12%-Income Tax Bracket 

You’re automatically exempt from long-term capital gains if you are between the 10%- and 12%-income tax bracket. However, there is a caveat for this provision. Thanks to the Tax Cuts & Jobs Act, ratified in 2018, people with incomes nearing the upper limit can be subject to the capital gains tax. After inflation adjustments, the 0% income tax rate in 2024 applies to incomes up to $47,025 for single filers or $94,050 for joint filers.

Some factors affect your ability to stay within the confines of this tax rule. For instance, the net profit from your stock sale increases your income toward the upper limit of your income bracket. Converting from a traditional IRA to a Roth IRA also affects your income tax bracket status.

Gifting stock to your underage children can compromise your income tax bracket. While gifts give you some tax advantages, they may count as income if you’re under 19 or full-time student under 24-year-old child sells their gifted stock, raising your income tax bracket. 

Leverage Tax-loss Harvesting

Did you know you can balance capital gains against capital losses to find your net gain or loss for tax purposes? The process is called tax-loss harvesting and you could end up with no capital gains after the counterbalance.

However, you can only deduct up to $3,000 of net capital losses annually against ordinary income on your tax return. Fortunately, you can carry over the remaining balance to subsequent years. Make sure to avoid wash sales rules if you intend to repurchase the stock soon.

Consider Stock Donations 

Instead of using proceeds from your appreciated stock sale after capital gains tax for charity donations, donate the stock directly. Donating shares held for more than one year has significant tax advantages.

  • You can deduct the full market value of the donated shares from your taxable income, reducing your tax liability substantially.
  • The donation amount becomes larger because you deduct the stocks' appreciated value rather than the purchase price, increasing your tax deduction as the recipient gets a more valuable donation.
  • Stock donations within the annual standard deduction limit also reduce your overall income.

Use Your Qualified Small Business Stock

If you have qualified small business stock (QSB) issued by a C corporation (C corp) held for at least five years, up to $10 million of your income or ten times the share cost can be exempt from capital gains tax. However, the C corporation's gross asset value should be below $50 million at the time of share issuance.

Take Advantage of Qualified Opportunity Zones

Low-income communities have incentives under the Tax Cuts and Jobs Act to avoid or postpone capital gains tax through Opportunity Zones. The zones offer tax-free and tax-deferred benefits when you invest accrued capital gains within 180 days in an Opportunity Fund and hold it for at least ten years to dodge.

You can postpone realized but untaxed capital gains until the end of 2026 by selling the investment. Your basis on the original share investment increases by 10% if you placed your capital gains in the Opportunity Funds for at least five years by the end of 2026. The basis rises by 15% if invested for seven years - since 2019.

You Can Choose to Die with Appreciated Stock

It may be extreme to choose this morbid option, but it’s feasible. Capital gains in your retail brokerage is the difference between sales proceeds minus the stock purchase price (cost basis).

If you sell during your lifetime, you incur capital gains. The cost basis transfers to the new owner if you gift the stock. If you die without selling or gifting, the cost basis takes the fair market value on the date of death, eliminating capital gains tax on the appreciation that occurred during your lifetime. The provision lowers or removes the capital gains tax for your beneficiaries. 

Disclaimer: Neither MML Investors Services nor any of its subsidiaries, employees or agents are authorized to give legal or tax advice. Consult your own personal attorney, legal or tax counsel for advice on specific legal and tax matters.

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