Topic:
CAPITAL GAINS TAX; INCOME TAX; TAX EXEMPTIONS;
Location:
TAXES - CAPITAL CAINS;

OLR Research Report


March 3, 2008

 

2008-R-0174

STATE INCOME TAX ON CAPITAL GAINS

By: Judith Lohman, Chief Analyst

You asked whether capital gains distributions are considered taxable income under Connecticut's personal income tax. You also asked if any other states exempt some or all capital gains from their income taxes.

SUMMARY

The federal tax code taxes net capital gains (gains minus losses) but at generally lower rates than other types of income. Federal tax rates on capital gains are lower for gains on assets held for more than one year. The federal tax law also exempts certain types and amounts of capital gains from taxation. The most notable federal exclusion is up to $500,000 in gains for joint filers from sale of a primary residence.

All 41 of the states with broad-based income taxes, including Connecticut, tax capital gains, but unlike the federal government, they do not typically have differential tax rates on such income. Fourteen states follow federal income tax rules and tax all net capital gains, while 27 provide various state exclusions and reductions for certain federally taxable capital gains. Connecticut excludes capital gains from the sale or exchange of Connecticut state or municipal bonds or notes from its income tax but follows the federal rules in all other respects.

Of the two states that tax only certain kinds of nonwage income, New Hampshire exempts all capital gains while Tennessee taxes capital gains distributions from mutual funds only.

FEDERAL CAPITAL GAINS TAXES

The federal capital gains tax laws are complicated. The following is a simplified description of the general rules for capital gains taxes on sales of most commonly held assets.

The federal government taxes net capital gains (capital gains minus capital losses), regardless of how long the assets were held. But until December 31, 2010, net capital gains are taxed at a lower rate than ordinary income. For taxpayers whose top marginal rate is 25% or higher, gains on assets held for more than one year (long-term capital gains) are taxed at a maximum 15% rate. For taxpayers in the 10% and 15% brackets, the maximum rate for long-term capital gains is 5% for sales through December 31, 2007 and zero for sales during 2008 through 2010.

After 2010, capital gains tax rates are scheduled to revert to the rates that were in effect prior to May 6, 2003; that is, 20% generally and 10% for taxpayers in the 15% bracket. Special rates of 18% and 8% will apply for sales of certain capital assets held for more than five years when the taxpayer is in the 10% or 15% bracket.

Under both rate structures, higher rates apply to gains from sales of certain types of assets, such as collectibles and qualified small business stock. Up to $250,000 of capital gains ($500,000 for joint filers) from the sale of a taxpayer's primary residence is exempt if the taxpayer meets certain conditions.

Taxpayers can reduce their taxable capital gains by subtracting their capital losses. Net capital losses are deductible from ordinary income up to a maximum of $1,500 per year ($3,000 for joint filers). Taxpayers can carry forward any excess capital losses to offset taxable income in future years.

CONNECTICUT'S CAPITAL GAINS EXCLUSIONS

The starting point for Connecticut's income tax is federal adjusted gross income (AGI), as listed on line 37 of IRS Form 1040, line 21 of Form 1040A, or Line 4 of Form 1040EZ. When calculating AGI, both Forms 1040 and 1040A require a taxpayer to include capital gains distributions, determined under the rules described above (Line 13 on Form 1040 and Line 10 on Form 1040A).

To determine Connecticut taxable income, Connecticut requires a taxpayer to make various additions to and subtractions from federal AGI. Under federal law, capital gains and losses on state and municipal bonds are treated the same as gains and losses on other assets. But Connecticut's income tax exempts gains from sales of Connecticut state or municipal bonds from state income tax. Thus, it requires taxpayers to subtract any such capital gains (and add back any capital losses) from their federal AGI when figuring their Connecticut taxes (CGS 12-701 (20)(A)(v) and (20)(B)(vii)).

With the exception of capital gains and losses from Connecticut state or municipal bonds, Connecticut follows the federal tax law for capital gains and losses.

CAPITAL GAINS EXCLUSIONS IN OTHER STATES

All states with state income taxes start with the federal definition of taxable capital gains. But in determining taxable income for state tax purposes, many states exclude certain capital gains that are taxable under the federal tax law. Table 1 shows how each state treats federally taxable capital gains income for state income tax purposes.

Information on capital gains income treatment in other states is based on a compilation of Individual Income Tax Provisions in the States by the Wisconsin Legislative Fiscal Bureau (January 2007). Since the Wisconsin report applies to the 2005 tax year, we updated the information by checking state income tax forms and instructions for the 2007 tax year.

Table 1: State Income Tax Treatment of Capital Gains & Losses

State

State Exemptions of Federally Taxable Capital Gains

Alabama

All gains are taxable and all losses deductible in the year incurred. Net loss deduction is not limited. No excess loss carryover.

Arizona

None

Arkansas

30% of long-term capital gain

California

None, although definitions and bases for capital assets may differ from federal definitions and rules.

Colorado

Qualified Colorado taxpayers may subtract gains from sale of (1) real or tangible personal property located in Colorado at the time of sale and (2) stock or ownership interest in a Colorado company, limited liability, or partnership. Assets must have been acquired on or after May 9, 1994 and the taxpayer must have held the asset for at least five uninterrupted years before the sale.

Connecticut

Gains/losses from the sale of Connecticut state and local bonds are subtracted/added back (see above).

Delaware

None

Georgia

None

Hawaii

For tax years 2008 through 2013, 100% of any gain from sale of leased fee interest in units within a condominium, cooperative, or planned unit development to an association of the apartment owners.

Idaho

60% of gain from sale or exchange of qualified property located in Idaho at the time of the sale up to the amount of net capital gain from all property included in federal taxable income. The exclusion applies to gains from sales of:

● Real property held for at least five years

● Tangible personal property used for at least 12 months by a revenue-producing enterprise in Idaho

● Cattle and horses held for at least 12 months for breeding, draft, dairy, or sporting purposes by an owner deriving more than 50% of his gross income from Idaho farming or ranching

● Breeding livestock other than cattle or horses held for at least 12 months by an owner deriving more than 50% of his gross income from Idaho farming or ranching

● Timber held by an owner for at least 24 months

Net capital gains the IRS treats as ordinary income are excluded. Allowable deduction is reduced, but not below zero, by the amount of any federal capital gains deduction related to the property.

Illinois

None

Indiana

None

Iowa

100% of capital gains resulting from sale of:

● Real property used in a business in which the taxpayer materially participated for 10 years and which has been held for at least 10 years immediately before the sale

● A business, including all or substantially all (at least 90%) of its tangible personal property or service, in which the taxpayer materially participated for 10 years, and which has been held for at least 10 years immediately before the sale. (Sale to a lineal descendant eliminates the requirement for the taxpayer's material participation.)

● Cattle and horses held for at least 12 months for breeding, draft, dairy, or sporting purposes by an owner deriving more than 50% of his gross income from farming or ranching. (Sale to a lineal descendant eliminates the 50% income requirement.)

● Breeding livestock other than cattle or horses held for at least 12 months by an owner deriving more than 50% of his gross income from farming or ranching. (Sale to a lineal descendant eliminates the 50% income requirement.)

● Timber held by an owner for at least 24 months

Sales of these items through partnerships, S corporations, and limited liability companies qualify if owners meet requirements for ownership and material participation. Sales by C corporations qualify except when due to liquidation. Shareholders must meet ownership and participation requirements.

Kansas

None

Kentucky

Gains from sales of:

● Kentucky Turnpike Bonds

● Property taken by eminent domain

Louisiana

None

Maine

Gains from:

● Fishing operations when contributed to a capital commission fund

● Investments in the Northern Maine Transmission Corporation

● Sales of bonds issued relative to the Maine Waste Management and Recycling Program

● Gains from ownership shares of a partnership, S corporation, or other pass-through entity that is a financial institution subject to the Maine franchise tax

● Gains on sale of multifamily affordable housing certified by the Maine State Housing Authority

Maryland

● Gains from sales or exchange of Maryland state or municipal bonds

● Capital gains distributions of a dependent child that the parent has elected to include in the parent's federal AGI

Massachusetts

None, although definitions and bases for capital assets may differ from federal definitions and rules.

Michigan

● Taxpayers aged 65 or over may subtract up to $9,420 in interest, dividends, and capital gains income ($18,840 for joint filers). The maximum must be reduced by the pensions subtraction claimed.

● All income, including capital gains, received by qualifying residents of Renaissance Zones, is exempt from tax. (Capital gains income may have to be prorated.)

Minnesota

Gain from sale of farm property, if insolvent at the time of sale.

Mississippi

None

Missouri

● 25% of gain from sale of qualifying federally subsidized housing project to a nonprofit or governmental organization

● Gains from sales of bonds issued by the Missouri Higher Education Loan Authority

Montana

● Capital gains from qualifying small business investment companies (SBICs) providing Montana employment opportunities

● 40% of capital gain from installment sales of capital assets entered into before January 1, 1987

● 100% of capital gain up to $50,000 from qualifying sale of at least 80 acres to a beginning farmer at 9% interest or less on a long-term contract

● 100% of federally taxable gain from liquidation of a corporation to the extent the gain is included in the liquidating corporation's gross income for Montana corporate license tax

Nebraska

Once-in-a-lifetime exclusion for gain from sale or exchange of stock in one “qualified” corporation acquired because of employment with, or while employed by, the corporation. A qualified corporation is one that has been doing business actively in Nebraska for at least three years and whose shareholders meet certain qualifications.

New Jersey

● Capital gains from sale of New Jersey state or municipal bonds or notes

● Capital gains from a New Jersey Qualified Investment Fund (a regulated investment company that invests at least 80% of its assets in federal or New Jersey state or municipal bonds)

Capital losses may only be netted against capital gains. Net capital losses are not deductible from ordinary income.

New Mexico

50% of federally taxable net capital gains or $1,000, whichever is greater. (Taxpayers claiming a tax credit provided in the Venture Capital Investments Act are not eligible for this exclusion.)

New York

100% of federally taxable gain from sale of qualifying “new business investment” issued before 1988 and held for at least six years

North Carolina

None

North Dakota

30% of federally taxable net long-term capital gain, including gain from a mutual fund

Ohio

Federally taxable gains from sale of Ohio public obligations

Oklahoma

● 100% of gains from sale of:

Real or tangible personal property located in Oklahoma and owned for at least five uninterrupted years prior to sale

Stock or ownership interest in an Oklahoma-headquartered company, limited liability company, or partnership if the stock or interest was owned for at least two uninterrupted years prior to sale

Qualifying Oklahoma state and local government obligations

● 50% of capital gain from sale to the state of Oklahoma of any historic 19th century battle site designated as a National Historic Landmark

Oregon

Gain on sale of depreciable property with a different basis for federal and Oregon purposes

Pennsylvania

Gain on sales of Pennsylvania state and municipal direct obligations originally issued before February 1, 1994

(Note: Pennsylvania does not distinguish between long-term and short-term gain, does not allow carryover of losses from one tax year to the next, and does not allow a loss from one class of income to offset a gain from another or a loss from one spouse to offset gains by the other.)

Rhode Island

Profit or gain for writers, composers, and artists living in defined Economic Development Zone in specified cities and creating artistic works while a zone resident.

South Carolina

44% of net long-term capital gain (assets held for at least one year)

Utah

100% of qualified capital gains if:

● the gain occurs on or after January 1, 2003,

● at least 70% of the proceeds are used within 12 months of the date the gain is recognized to purchase qualifying stock in a Utah small business corporation, and

● the taxpayer did not have an ownership interest in the Utah small business corporation that issued the qualifying stock.

Vermont

● 40% of federally taxable net capital gain

● Tax credit for investing capital gain in eligible venture capital business equal to 3% of the gain invested

● Credit equal to 7% of gain from sale of a mobile home park to a group made up of a majority of the park tenants or to a nonprofit organization representing such a group

Virginia

Gain on the sale or exchange of real property or easement to real property which results in the property or easement being devoted to open space

West Virginia

None

Wisconsin

40% of gain from sale of:

● Business or farming assets to a qualified relative if the taxpayer held the asset for at least 12 months

● Corporate or trust shares if (a) there are no more than 15 shareholders or beneficiaries, with groups of certain taxpayer relatives counted as one shareholder or beneficiary; (b) the corporation has no more than two share classes; and (c) all shareholders and beneficiaries are natural persons

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