- Let's talk about the two different kinds of income.
There's ordinary income
and there's capital gains income.
Ordinary income is just what it sounds like.
Ordinary income is justwhat it sounds like:
ordinary income such as wages, salary,
Ordinary income such as wages, salary,
and interest on your bank account.
Capital gains income arises
Capital gains income ariseswhen you make an investment
when you make an investment
and the value of the investment increases.
Let's say you have a stock portfolio.
Hopefully you're going to buy low and sell high.
Let's say I buy at $1000 and then sell at $1300.
The $300 increase is called capital gains income.
So there's ordinary income,
wages, salary, interest on bank accounts.
interest on bank accounts,
And there's capital gains income.
Income from the increase in value of investments.
World wide and particularly in the United States,
Capital gains income is typically taxed
at a lower rate than is ordinary income.
Now we could get in a long philosophical discussion
Now, we can get in a longphilosophical discussion
about whether this is right or wrong.
Let me just give you the rationale
on both sides of the argument.
The reason that capital gains income
is typically at a lower rate
is that governments want to encourage people to invest.
In addition people say listen,
if I'm going to invest money in a stock portfolio,
I already paid tax on that investment money
when I originally made it.
You're going to tax me again when I invest it?
Now, on the other side,a very reasonable view
Now on the other side,
a very reasonable view is that income is income.
is that income is income.
There's no difference between ordinary
and capital gains income.
It's just a different way to make income.
Capital gains income should be taxed
at the same rate as ordinary income.
So those are the arguments on both sides.
The fact is that in most jurisdictions
around the world capital gains income
capital gains income istaxed at a lower rate.
is taxed at a lower rate.
In fact in some places,
In fact, in some places,capital gains income
capital gains income is not taxed at all.
is not taxed at all.
In the United States ordinary income
is taxed at one rate,
capital gains income is taxed at a lower rate.
capital gains income istaxed at a lower rate.
Let's go back to our Simple Tax System.
For income from $0-$50,
where income from $0-50 youdon't pay any tax at all.
you don't pay any tax at all.
That's the first tax bracket.
For income above $50,
the tax rate differs depending on the type of income.
depending on the type of income.
If it's ordinary income the rate is 50%.
If the income is capitalgains income, the rate is 20%.
If the income is Capital gains income the rate is 20%.
Okay, how much income tax would you pay if you made $100?
Okay, how much income taxwould you pay if you made $100?
Well if the $100 is ordinary income,
Well, if the $100 is ordinary income,
meaning you just went to your job and that's your wage,
the tax is $25 as we've computed before.
the tax is $25, as wehave computed before.
If on the other hand,
If, on the other hand, this $100 income
this $100 income is capital gains income,
is capital gains income,
the first $50 is not taxed at all,
and the second $50 would be taxed at the lower
at the lower capital gains rate of 20%.
capital gains rate of 20%.
You'd only pay $10 in tax.
So if somebody gives you your choice,
do you want to classify this income
as ordinary income and pay $25 tax,
and pay $25 tax, or capitalgains income and pay $10 tax?
or capital gains income and pay $10 tax.
Of course if it's legal,
you'd prefer to pay the lower $10 tax
the lower $10 tax on capital gains income.
on capital gains income.
Here's where a lot of complex
Tax Shelter arrangements arise.
Tax Shelters take on many forms.
One form is structuring your affairs
so that income can be classifiedas capital gains income
so that income can be classified
as capital gains income rather than ordinary income.
rather than ordinary income.
Lots of things, both legitimate and shady,
Lot's of things, both legitimate
and shady have been done to create tax shelters
have been done to create tax shelters
to change the nature ofincome from ordinary income
to change the nature of income
from ordinary income to capital gains income.
to capital gains income.
People prefer to have any income they make
classified as capital gains income
if at all possible so that the income
is taxed at the lower capital gains rate.
at the lower capital gains rate.