When is the last time you legally paid 0% tax on income?

The problem is, millions of Americans who have the opportunity to do so this year are not even aware of it.

Five years ago, in order to jump-start the economy and get us out of the post-9/11 recession, Congress temporarily slashed the tax rate on long-term capital gains. The top rate of 20% was cut to 15%; individuals in the two lowest income tax brackets would pay even less- just 10%. Then, for one year only -- 2008 -- the 10% rate would drop to zero.

Furthermore, the same rates would apply to dividends paid on most shares of corporate stock.

The party was scheduled to be over at the end of this year, when rates would revert back to their original levels. But in 2006, for reasons too complex to go into here, Congress voted to extend them through 2010.

Although you might not be in a low-enough income tax bracket to take advantage of the 0% long-term capital gains rate, odds are you know someone who is.

An adult child, for instance.

Here’s one scenario, according to attorney Marc Soss in Bonita Springs, Fla.: Assume mom and dad invested $10,000 in a mutual fund 10 years ago. Today it’s worth $20,000.

Mom and dad are in the 30% tax bracket, so if they sell the mutual fund shares, they’ll lose 15% of the profit (roughly $1500) to capital gains tax. Instead, they make a joint gift of the shares to their daughter, who just graduated from college in June. (1)

Because daughter will only be employed half the year and isn’t earning that much in her first job, she’ll fall into the 10% income tax bracket for 2008. As a result, when she sells the mutual fund shares for $20,000, she owes no tax on the gain.

Voila! Mom and dad have given their daughter “a $20,000 gift for the price of $10,000,” says Soss.

In order for this to work the child must be older than age 19, or at least age 24 if she is a full-time student and still declared a “dependent” on mom and dad’s income tax return. Otherwise, the so-called “kiddie tax” rules apply and the child will be taxed at the same rate that mom and dad would pay.

Soss, a navy reservist who’s served multiple tours of duty in Afghanistan, says the same strategy “would substantially benefit people in the military who are deployed” in a combat zone. That’s because income earned in a war zone is tax-free. Even if a spouse back at home worked, there’s a good chance the couple’s joint income would fall into one of the two lowest income tax brackets.

“Say I’m deployed,” says Soss. “My parents could gift me stock. I could sell it” and not have to pay any capital gains tax.

Retirees are another group whose income might be low enough to allow them to take advantage of the 0% tax rate on long-term capital gains and dividends.

Let’s say you routinely send money to help your parents who are retired, living on Social Security, and fall into the 15% tax bracket. “An easy way to help support them is by making a gift of appreciated stock. It’s better than giving them cash,” advises Soss.

From a tax standpoint, it not only benefits mom and dad, it benefits you, the child, since you’re probably in one of the higher tax brackets. As a result, if you sold the stock, you’d get hit with a 15% tax on the gain. In contrast, mom and dad can sell the stock and keep the entire amount. The net result is you’re able to get more money into mom and dad’s hands on an after-tax basis.

Another strategy for retirees is to reduce the amount of income you’re living on so that you fall into one of the two lowest income tax brackets. You might accomplish this by delaying the onset of Social Security benefits, or (provided you’re not over the age of 70½) by not taking withdrawals from retirement accounts such as a 401(k), IRA, 403(b), etc. Instead, Soss recommends you sell appreciated assets -- stocks, bonds, mutual fund shares -- in taxable accounts. Provided you’ve owned an asset for at least a year, you’d pay no capital gains tax on the profit you make when you cash it in.

Caution! You don’t want to go overboard with this. If an individual in the 10% or 15% tax bracket reaps too large a capital gain, it could throw them into a higher tax bracket and negate the whole strategy. Soss recommends you “sit down with a CPA and calculate” how large a capital gain you can safely declare.

One final note: Although he admits it’s his personal opinion, Soss thinks that the reduced tax rates on dividends and capital gains might disappear sooner than expected because “one of the positions President-elect Obama ran on is to increase… the tax on the wealthy.”

While the political rhetoric is that stock dividends are largely earned by high-income investors, this is far from the case. Millions of individuals own mutual funds that hold stocks and other assets. These folks have enjoyed smaller tax bills on the dividends paid on the stock owned in their funds because these are passed through to investors. They’ve also been paying less tax on the capital gains their mutual funds report as a result of selling bonds, stocks, and other long-term assets.

Soss is so convinced the new administration will make raising the capital gains tax a priority, he’s recommending upper-income clients consider selling any capital asset that’s worth more today than what they paid for it “to lock in today’s capital gains rate.”

If you really love your stock/bond/mutual fund/etc. and are convinced it’s a good investment, you can buy it back immediately. As Soss explains, as long as the “stock has gone up, there’s no ‘wash sale’ rule. You can buy it back 10 minutes later.” (2)

Although you’re “paying capital gains tax of 15%, we don’t know what capital gains tax will be in the future. What you’ve done is lock in a higher cost basis.”

(1) This year (2008) an individual can give (gift) another person up to $12,000 in assets without owing gift tax. A married couple can make a combined gift of $24,000 to the same individual and not have to file a gift tax return. Next year (2009) these amounts increase to $13,000 and $26,000 respectively.

(2) In order to take a tax deduction for a loss in a capital asset, the so-called “wash-sale rule” requires that you wait 30 days before buying it back. There is no waiting period when an asset is sold for a gain.

If you have a question for Gail Buckner and the Your $ Matters column, send them to: yourmoneymatters@gmail.com, along with your name and phone number. Click here for the Your Money Matters Archive