Do small investors ever get a free lunch on Wall Street? The answer is actually yes, although we’ll have to wait until 2008, 2009 and 2010. Thanks to a new tax law, we won’t have to pay federal income taxes on stock dividends and long-term capital gains those years, provided we stay at least within the 15 percent tax bracket. This significant tax break, part of the Tax Increase Prevention and Reconciliation Act passed by Congress last month, has gone almost unnoticed. Just about all the news reports I’ve seen or heard have simply said the legislation extends for two years the reduced 15 percent tax rate for dividends and capital gains, which was set to expire after 2008. For a married couple filing jointly, the $68,700 translates to a taxable income of $51,800 after subtracting $6,600 in personal exemptions and the $10,300 standard deduction. The ceiling for the 15 percent tax bracket is $61,300 in 2006, so this couple could make at least an additional $9,500 in dividends and long-term gains and pay a tax of only $475 or 5 percent, rather than $1,425 at a 15 percent rate. And in 2008, 2009 and 2010, they would pay nothing. Because tax-bracket ranges and exemption and deduction amounts are indexed for inflation each year, this couple would likely remain in the 15 percent bracket even if they receive cost-of-living increases. “The law encourages a very favorable investment climate for long-term investors,” said Sam Beardsley, director of investment taxation for T. Rowe Price, a financial services and mutual fund firm. “And it really favors stocks over bonds,” because interest from bonds is deductions in a particular year. Hold stocks or mutual funds that pay out a large amount of qualifying stock dividends (your fund or adviser should be able to explain which dividends qualify) in taxable accounts, not traditional IRAs. Distributions from traditional IRAs are taxed at our marginal tax rate and do not qualify for the lower rate for dividends or long-term gains. Be a smart seller. Keep confirmation statements of all your fund transactions. When you sell, you can cherry-pick the specific shares you are selling and possibly realize tax-free gains in 2008-2010. (You must hold the shares for more than a year for a gain to be considered long term.) And, subject to any internal restrictions imposed by a fund firm against rapid trading, you could sell appreciated shares in 2008 (or 2009 or 2010) and buy them right back, paying no taxes and locking in a higher tax basis for future sales. “That’s pretty clear in the law,” said Mark Luscombe, principal tax analyst for tax publisher CCH, a Walter Kluwer business. “You are free to realize a gain and immediately buy back” the same securities. Humberto Cruz offers personal finance advice. Write him at [email protected] local news?Sign up for the Localist and stay informed Something went wrong. Please try again.subscribeCongratulations! You’re all set! AD Quality Auto 360p 720p 1080p Top articles1/5READ MORE11 theater productions to see in Southern California this week, Dec. 27-Jan. 2But the 15 percent is the maximum rate, and it applies just to taxpayers in the 25 percent tax bracket and higher. Only about one-fourth of U.S. taxpayers are in such high brackets, according to Internal Revenue Services statistics I looked up. For the other three-fourths in the two lowest 10 percent and 15 percent brackets – count my wife, Georgina, and me among them – the tax rate for stock dividends and long-term gains is just 5 percent now and will drop to zero – nada, zilch – not only in 2008 as previously scheduled, but also in 2009 and 2010. Based on industry statistics, I figure the average mutual fund investor – the prototypical small investor in the United States – qualifies for the 5 percent rate now and can expect to qualify for the zero percent rate from 2008 to 2010. Let’s compute the potential tax savings. According to the Investment Company Institute, a trade group for the mutual fund industry, the median annual household income of the 91 million Americans who own mutual funds is $68,700 (half make more than $68,700 and half make less).