How Does the Dividend Tax Cut Affect Capital Gains?

Dear Beverly,

I'm a longtime reader of TheStreet.com -- thanks for your clear, concise articles.

My longwinded question:

It's my understanding that, with the new, lower 15% dividend tax rate kicking in, dividends can no longer be counted against capital losses.

If that's correct, it's difficult to see why this change should be seen as a plus. Most educated investors -- at least the ones I know -- were able in the past to wipe out virtually all of their taxable dividend gains by selling their clunkers at the end of the year. But now, it seems there is no way around paying tax on dividends.

Do I have my facts wrong? If not, who actually benefits from this change? I'd appreciate any insights you might have.

Best,

Dan A.

Sorry, Dan, but you can't avoid paying taxes on dividends by using capital losses to offset your dividend income. That, however, is not a new rule.

Even prior to this year's tax cut, dividend income was never a factor in the "match game" of using capital losses to offset capital gains, thereby reducing or even eliminating the taxes owed on profitable sales.

This year's tax cut didn't really change the matching rules, but it did add some complexity. In short, capital losses must offset capital gains. If your losses exceed your gains, you can offset up to $3,000 in ordinary income. Ordinary income includes any money that gets taxed at your income tax rate -- including your salary and income from bonds, real estate investment trusts and, in the past, stock dividends.

Here's a quick overview: You can use any amount of loss to offset any amount of gain, but it must be done in a particular order.

First, separate your short-term and long-term gains and losses. Initially, you must only use short-term losses (including short-term losses that have been carried over from prior years) to offset short-term gains, and long-term losses to offset long-term gains. Only if you have an excess of one or the other type of loss can you then apply it to gains from another category. Then if you still have losses to report, you can then reduce your ordinary income by as much as $3,000 per return, regardless of whether you file singly or jointly. Any remaining losses can be carried over to future years to offset future gains and/or ordinary income.