President Joe Biden ran his capital gains tax proposal up the proverbial flagpole. If enacted, it would impact just taxpayers with incomes over $1 million. Those wealthiest Americans would see their long-term capital gains taxed at a new, higher top rate of 39.6%.
That new top rate would almost double replace today’s top rate of 20%.
“Should you be alarmed? Maybe. But odds are you won’t be affected. In 2018 there were 539,207 tax returns for AGIs over $1 million, making up about 0.35% of all returns filed, Watson says. And Biden seems to be targeting just returns with “taxable income,” which is a subset of AGI.
In other words, even fewer than 0.35% of all returns would be hit by the new, higher cap gains rate.
Capital Gains Tax: Don’t Forget The Net Investment Income Tax
The 39.6% rate would be in addition to the current 3.8% net investment income tax (NIIT), for a combined total of 43.4%.
The 3.8% surtax, which helps fund the Affordable Care Act, widely known as Obamacare, is also assessed in addition to today’s top rate of 20% for taxpayers whose income is high enough.
How High Does Biden Want The New Capital Gains Tax To Go?
But the new 39.6% top rate would take effect only if passed by the House and Senate. And the proposal will likely be subject to revisions between now and any vote, says Tim Speiss, partner in EisnerAmper’s Personal Wealth Advisory Group, who follows tax legislation.
The final size of an increase in the capital gains tax could be smaller, Speiss says. Also, a smaller set of taxpayers might see it applied to them, he adds. “It’s already being debated behind closed doors,” on Capitol Hill, he said.
Major tax changes often do not reach a vote until late in any calendar year, Speiss says. So this proposal could be subject to many months of compromises.
Final Version May Not Be So High
“I would not be surprised if we see a graduated capital gains tax increase,” Speiss said, referring to the possibility of a congressional compromise on a new top capital gain rate between 20% and 39.5%, or even a stepped increase with more than one new, higher rate.
And Biden might provide more details at or before his Wednesday speech to a joint session of Congress.
Biden’s New Top Capital Gains Tax Rate Hits Who?
At the moment, here is how Biden’s long-term capital gains tax would work. It would apply to stocks and bonds sold in 2021, for example, after owned more than 12 months. Here are the top rates that would apply to investors in several filing statuses and with various levels of yearly income:
|Single filers||Heads of household||Married joint filers|
|15% Top Tax Rate||up to $445,850||income up to $473,750||up to $501,600|
|20% Top Tax Rate||$445,850 to $1 million||$473,750 to $1 million||$501,600 to $1 million|
|39.6% Top Tax Rate||$1 million and above||income up to $1 million+||$1 million+|
Short-Term Capital Gains Rates Would Still Exist
Profits on securities sold after being held less than one year would continue to be taxed as short-term capital gains. Those gains face ordinary income tax rates. The top short-term capital gains tax rate is 37%.
Biden’s proposal is part of his American Families Plan, he said last week.
History Of The Top Long-Term Capital Gains Tax Rate
The top long-term capital gains rate has been 20% since 2013, according to Wolters Kluwer. It was just 15% from part of 2003 through 2012. It was 20% from 1997 through part of 2003, and again from part of 1981 through 1986.
In all other years since roughly U.S. entry to World War II, the top long-term capital gains rate was higher than 20%.
And those peak rates ranged from 25% to 35%.
Five Reasons Not To Panic
So, should investors abandon securities on which they might be assessed capital gains taxes? Speiss says there are five reasons not to take such a step now.
First, passage of Biden’s capital gains tax rate is hardly assured. The Senate is split between Democrats and Republicans, where centrists hold key influence. In the House, Democrats hold only a slim majority.
Second, the size of any such higher cap gains tax could change. The top rate could end up lower than 39.6% because of political give and take.
Likewise, Congress may raise the income level at which a new, higher capital gains tax rate applies. That would exempt even more taxpayers from the higher capital gains tax rate.
Fourth, capital gains that occur inside a tax-sheltered account such as an IRA are not subject to capital gains tax.
Fifth, dividend yield and interest income may make capital gains taxes palatable.
Overall, you should not let your tax tail wag the dog, Speiss says. “Judge your investments on their investment merits, not tax consequences,” Speiss said.
Your net investment profit on a security that appreciates a lot in value may still be sizable, even after accounting for any tax, Speiss says.
Follow Paul Katzeff on Twitter at @IBD_PKatzeff for tips about retirement planning and active mutual fund managers who consistently outperform the market.
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