Tax Watch: Proposed Changes to Capital Gains
This week, the markets had a small reaction to news that President Biden is seeking to change the capital gains tax rate for the highest income tax payers. Here is a brief explanation of what to consider:
The "American Families Plan" will focus on items such as childcare and paid leave for workers. It is the anticipated sequel to the infrastructure plan that the President proposed a few weeks ago. The announcement of the plan should unfold in the coming days and with it a proposal to nearly double the highest capital gains tax rate to pay for the plan.
As a reminder, a capital gain is when you buy an asset like a stock or a property, hold it for a period of time, then sell it for a profit. When you sell, the asset, the gain is the money that you have made above what you paid for it. If you held the asset under a year, then it is considered short-term and you pay ordinary income tax on the gain. However, if you hold the asset over a year, the gain receives special tax treatment.
Here is how Capital Gains are currently taxed:
The proposed changes that we have heard would raise the long-term rate to 39.6% for tax-payers that earn over $1 million dollars.
So, it seems that this change in taxes will only target the highest income earners. However, there are few details that need to be worked out to fully understand how this change may affect the normal investor.
The first big question is how the $1 million dollars is defined. We need to know if this is earned income or any income. As it stands, it seems that it will be the latter, which is not the best news. If the capital gain generated from the sell of an asset is counted toward income, it might be easier to move above the $1 million mark in a given year. Consider the sales of homes, properties, businesses. Assets like these that may have appreciated considerably could be targeted by this increase in taxes.
An additional concern is that the tax change could have a ripple effect with larger investors being disincentivized and selling off assets before the tax change.
In reality, the expectation is that the proposed number won't be the law that is passed. Many feel that there is not enough support to push the tax that high, especially without some concessions on other taxes like state and local tax deductions. We will have to see where the final target lands.
Remember that this is nothing new. President Biden was discussing these changes on the campaign trail and the capital gains rate has been changed before. There were changes under both Presidents Bush and Obama. The markets will adapt and our planning strategies will take what laws we are given and work for the best possible outcomes.
If you have questions or concerns about your tax strategy, please reach out to us for a discussion.