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Updated August 07, 2024 Reviewed by Reviewed by Lea D. UraduLea Uradu, J.D. is a Maryland State Registered Tax Preparer, State Certified Notary Public, Certified VITA Tax Preparer, IRS Annual Filing Season Program Participant, and Tax Writer.
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Part of the Series Income Tax Term GuideTypes of Income
Tax Types and Terms
CURRENT ARTICLEIncome tax is paid on earnings from employment, interest, dividends, royalties, or self-employment, whether those earnings are in the form of services, money, or property.
Capital gains tax is paid on income that derives from the sale or exchange of an asset, such as a stock or property that’s categorized as a capital asset.
Below is a primer on the difference between income tax and capital gains tax and how this information might help you lower your taxes.
Your income tax rate varies based on your specific tax bracket, and the tax bracket depends on how much income you make in an entire calendar year.
Tax brackets also vary depending upon whether you file as an individual or jointly with a spouse. Federal income tax rate rates range from 10% to 37% of a person’s taxable yearly income after deductions.
The U.S. has a progressive tax system. Lower-income individuals are taxed at lower rates than higher-income taxpayers on the presumption that those with higher incomes have a greater ability to pay more.
In addition, the progressive system is marginal. That means that different segments of your income are taxed at different rates. For example, in 2024, the rates for a single filer are as follows:
For 2023, they were:
The tax rates used for capital gains depend on how long the seller owned the asset. Short-term capital gains, those that apply to assets held for one year or less, are taxed at ordinary income rates. However, if you hold an asset for more than a year, then more preferential long-term capital gains rates apply. These rates are 0%, 15%, or 20%, depending on your income level.
For tax year 2024, a single filer pays 0% on long-term capital gains if their income is $47,025 or less. The rate is 15% if the person’s income is from more than $47,025 to $518,900. It's 20% if income is over $518,900.
For tax year 2023, a single filer paid 0% on long-term capital gains if their income was $44,625 or less; 15% if it was over $44,625 to $492,300; and 20% if their income exceeded $492,300.
Holding an asset for one day longer than one year means an investor may save money on taxes. That is, they'd pay a long-term capital gains tax of 0%, 15%, or 20% versus the short-term capital gains rate, which is the same as a (most likely) higher ordinary income tax rate.
To calculate a capital gain, first determine the cost basis of the asset. Then, subtract that from the sales price of the asset.
If you purchase a property for $10,000, for example, and spend $1,000 on improvements, then your basis is $11,000. If you then sell the asset for $20,000, your gain is $9,000 ($20,000 minus $11,000).
Say that Joe Taxpayer earned $35,000 in 2023. Where his income tax is concerned, he would have paid 10% on the first $11,000 of income and 12% on the income he earned beyond that, up to $44,725 ($35,000 - $11,000 = $24,000). His total tax liability was $3,980.00 ($1,100.00 + $2,880).
As for capital gains taxes, if Joe sold an asset that produced a short-term capital gain of $1,000, then his tax liability rose by another $120. That's calculated as the short-term capital gains tax rate (his income tax bracket rate) of 12% x $1,000.
However, if Joe waited one year and a day to sell, then he would have paid the long-term capital gains tax rate of 0% (in line with the annual income threshold).
Donald P. Gould
Gould Asset Management, Claremont, CA
The IRS separates taxable income into two main categories: “ordinary income” and “realized capital gain.” Ordinary income includes earned wages, rental income, and interest income on loans, CDs, and bonds (except for municipal bonds). A realized capital gain is the money from the sale of a capital asset (stock, real estate, etc.) at a price higher than the one you paid for it. If your asset goes up in price but you do not sell it, you have not realized your capital gain and therefore owe no tax.
The most important thing to understand is that long-term realized capital gains are subject to a substantially lower tax rate than ordinary income. This means that investors have a big incentive to hold appreciated assets for at least a year and a day, qualifying them as long-term and for the preferential rate.
Yes, they can. As an example, President Joe Biden proposed in the first half of 2024 that the maximum capital gains tax be raised from 20% to almost 40% for investors making at least $1 million per year.
For the 2024 tax year, individual filers won't pay a capital gains tax if their total taxable income is $47,025 or less.
That depends on whether the capital gains are long term or short term. Long-term capital gains may push you into a higher capital gains tax bracket but will not affect your ordinary income tax bracket because such gains are not treated as ordinary income.
Assets sold within a year are short-term gains and they are considered ordinary income. Therefore, they could push you into a higher marginal income tax bracket.
The difference between the income tax and the capital gains tax is that the income tax is applied to earned income and the capital gains tax is applied to profit made on the sale of a capital asset.
The capital gains tax can be either short term (for a capital asset held one year or less) or long term (for a capital asset held longer than a year). Long-term capital gains cannot push you into a higher income tax bracket. Only short-term capital gains can accomplish that because those gains are treated as ordinary income. So any short-term capital gains are added to your income for the year.
Be sure to check income tax and capital gains income brackets each year because the Internal Revenue Service (IRS) typically adjusts them annually due to inflation.