Head-to-head
Capital Gains vs Income Tax
The tax rate on a gain depends on how long you held the thing that produced it, not on how the money arrived. Hold an asset for more than a year and the profit is a long-term capital gain, taxed at its own lower schedule. Hold it for a year or less, or earn the same money as wages, and it is ordinary income taxed at your marginal rate.
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The gap is not small once you are past the middle brackets. A single filer in the 24% bracket pays 24% on an extra $10,000 of salary and 15% on an extra $10,000 of long-term gain — plus, above the threshold, the 3.8% net investment income tax, which is levied on the investment income rather than on the wages.
Three details decide whether that comparison applies to you. The first is the holding period: one day short of a year and the whole gain reverts to the ordinary rate. The second is the surtax threshold, which is not indexed for inflation and applies to net investment income above $200,000 for a single filer. The third is that capital losses only offset capital gains, plus $3,000 of ordinary income a year, with the rest carried forward.
What the lower rate actually buys is patience. It is not a loophole for investors as a class — it is a payment for deferring the sale, which is also why the same asset sold in December and in January can produce two very different bills.
Capital gain
How To Calculate Capital Gains Tax
When an asset is sold for more than it cost, the profit is a capital gain. Holding it over a year usually earns a lower long-term rate, while a shorter holding is taxed at the ordinary income rate.
Ordinary income
How To Calculate Income Tax
Income tax is progressive: each slice of income is taxed at its own rate, so the whole amount is never taxed at the top rate. The effective rate is what you actually pay; the marginal rate is what the next dollar costs.
How They Differ
| Attribute | Capital gain | Ordinary income |
|---|---|---|
| Rate at the top bracket | 15%, plus 3.8% above the threshold | 24% in the same bracket |
| Holding period | More than one year | Any |
| What is taxed | Sale price minus cost basis | Wages, interest, short-term gains |
| Losses | Offset gains, then $3,000 of income | Not deductible |
| Timing | You choose when to realise it | Taxed as you earn it |
| Withholding | None until you file | Withheld at source |
| Surcharge | 3.8% net investment income tax | Medicare, already inside the rate |
| State treatment | Usually the ordinary rate anyway | Ordinary rate |
| Room to plan | Large: harvest losses, choose lots, pick the year | Almost none |
The Same Numbers, Both Ways
A single filer in the 24% bracket with $10,000 of profit, comparing a long-term capital gain against the same $10,000 earned as ordinary income.
- Amount
- $10,000
- Ordinary marginal rate
- 24%
- Long-term capital gains rate
- 15%
- Net investment income tax
- 3.8%
| Line | Capital gain | Ordinary income |
|---|---|---|
| Rate applied | 15.0% | 24.0% |
| Tax on the $10,000 | $1,500.00 | $2,400.00 |
| Net investment income tax | $380.00 | $0.00 |
| Total tax | $1,880.00 | $2,400.00 |
| You keep | $8,120.00 | $7,600.00 |
| Holding period needed | More than one year | None |
| Losses usable against it | Yes, dollar for dollar | No |
The same $10,000.00 costs $2,400.00 as ordinary income and $1,880.00 as a long-term capital gain, so the gap is $520.00. It is not a discount for investing: it is a discount for waiting, because the 15.0% rate only applies once the asset has been held for more than a year, and the surtax claws back $380.00 of it above the threshold.
When To Use Each
Capital gain
- You are selling an asset you have held for more than a year and can choose the tax year of the sale.
- You have unrealised losses elsewhere that can be harvested to offset the gain in the same year.
- Your income is high enough that the difference between the ordinary and preferential rates is material.
Ordinary income
- The money arrives as wages, interest, a bonus or a short-term trade — there is no preferential rate available.
- You are estimating the tax on a salary increase or a side income, where no basis or holding period exists.
- You need the total bill rather than the marginal one, including deductions and credits.
Common Questions
Is the 15% rate available to everyone?
No. The 0%, 15% and 20% bands depend on taxable income, and the 20% band starts well above the 24% ordinary bracket. Below the threshold a long-term gain can be taxed at 0%, which is the most valuable case and the one most often missed.
How is the holding period counted?
From the day after you bought to the day you sold, and it must be more than one year. Buying on 3 January and selling on 3 January the following year is exactly one year, which is not more than one year, so the gain is short-term.
Does the 3.8% surcharge apply to wages?
No. It applies to net investment income — interest, dividends, rents and capital gains — and only to the extent your modified adjusted gross income exceeds the threshold. Salary is not subject to it, though salary is often what pushes you over the line.
Can I choose which shares I sold?
Usually yes, if you specify at the time of sale instead of letting the broker default to first in, first out. Specific identification lets you sell the lots with the highest basis and keep the taxable gain small.
What if my losses are bigger than my gains?
You net them against gains first, then deduct up to $3,000 against ordinary income, and carry the remainder forward indefinitely. A large loss year is worth planning around rather than rushing through in December.
More Comparisons
- Effective Tax Rate vs Tax Bracket
Your bracket is the rate on your next dollar; your effective rate is what you actually paid. On $120,000 of income with $18,000 of tax the bracket is 22% but the effective rate is 15% — and that gap is the whole point of a progressive system.
- ROI vs CAGR
ROI measures the whole return; CAGR turns it into a compound annual rate. A 100% return over five years is 20% a year by division but 14.87% a year in reality.
- Simple Interest vs Compound Interest
Simple interest charges the principal only; compound interest charges the balance. On $10,000 at 5% over 10 years that gap is $1,288.95 — here is where it comes from.
Sources
- Topic no. 409 — capital gains and losses — Internal Revenue Service
- Topic no. 559 — net investment income tax — Internal Revenue Service
- Publication 550 — investment income and expenses — Internal Revenue Service
Both methods sit in Finance.