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Capital gain tax rates could nearly double under a Biden proposal. How would that your investments?
Biden stimulus package details of $1.8 trillion American Families PlanBiden stimulus package details revealed: American Families Plan includes free childcare, community college, and possible hike of capital gains tax.Staff Video, USA TODAYThe past year has brought all sorts of federal tax adjustments and changes: stimulus payments, untaxed unemployment compensation, more lenient treatment of retirement withdrawals, an extended return-filing deadline and more.The next big move on the individual side could be higher capital gain taxes.President Joe Biden has proposed a near-doubling of the maximum federal rate on capital gains or investments held more than one year to 43.4% to help fund $1.8 trillion in new spending initiatives that include child care, pre-kindergarten education, tuition-free community college and paid family leave.That’s in addition to a proposed hike in the top rate for regular income to 39.6% from 37% and a bump up in the corporate tax rate to 28% from 21%. Dividends for wealthy people also could be subject to the same, higher proposed rate as on capital gains.When will child tax credit payments start: Checks set to roll out in July, IRS says4th stimulus check?:Americans are looking for clues.Here are some of the ramifications for wealthy taxpayers and financial markets under the still-uncertain scenario that Biden’s proposal goes through unaltered:What’s the rationale for a rate hike?In part, Biden needs to raise money to pay for those family-oriented initiatives. There’s also a desire among Democrats to make the tax code more “fair” by equalizing the treatment of income, whether derived from wages or investment earnings.At the low end of the scale, people generate most or all of their income from wages. For those at the top, capital gains often dominate, especially after a strong stock- market year like 2020. This means the wealthy can wind up paying effective tax rates below those paid by many middle-class families, according to a White House fact sheet.”The proposal reverses a long-standing tax code philosophy that treats returns on investments more favorably than labor income (or) wages,” said Jack Ablin, chief investment officer at Cresset, an investment company.Of course, less-affluent people pay long-term capital gain rates below what the wealthy face. The vast majority of taxpayers in the middle face a 15% long-term levy, while those near the bottom of the income scale can qualify for a 0% rate.Who would pay the tax?The White House claims only those people with incomes above $1 million would pay the higher capital gain tax – a mere 0.3%, or 3 out of 1,000 taxpayers. The vast majority of Americans would see no increase in the capital gains levy.Critics such as Douglas Holtz-Eakin, president of the center-right American Action Forum, call the 0.3% figure misleading because wealthy people own a disproportionately large share of stocks and other investments, so the economic and market impacts could be much broader.Then again, an estimated 70% to 75% of investors – foreigners and pension funds among them – don’t face capital gains. Nor do capital gain taxes apply on money taken from 401(k)s, IRAs and other such accounts. Those withdrawals come out as ordinary income (with tax-free Roth IRAs an exception).Plus, homeowners can shield up to $250,000 in housing profits from capital gains ($500,000 for married joint filers) if they own and live in their residence for at least two of the five years prior to sale. But Biden’s plan would prohibit more complex tax-free real estate transfers known as 1031 exchanges when gains exceed $500,000.Could rich taxpayers avoid the tax?To some degree, yes. One avoidance strategy would be to hang onto stocks or other investments indefinitely, or at least until a wealthy individual has a year when regular income comes in below $1 million.The Congressional Joint Committee on Taxation and others have estimated a capital gains rate around 28% is optimal for maximizing revenue without encouraging droves of people to delay or avoid the tax by not selling. Biden also proposed subjecting the wealthy to a tax on unrealized profits at death, which would be a way to tax these assets eventually. But this idea has problems, including the difficulty heirs would face in trying to calculate initial purchase prices on assets possibly acquired decades earlier. Some higher-end taxpayers would certainly harvest gains by selling assets before the higher rates kick in, assuming any rate increase isn’t retroactive.How high might rates go?High-end investors currently pay 23.8% on long-term capital gains (a 20% rate plus a surtax of 3.8% on net investment income to help finance Medicare). The Biden plan would raise that to 43.4%, or 39.6% plus 3.8%. The surtax also applies to dividends, interest and other revenue beyond just capital gains.The combined capital gains levy would be even higher if you include similar taxes imposed by most states. The combined rate would be 56.7% in California and 54.3% in New York, to cite two examples provided by the Tax Foundation. In Arizona, it would be 49.4%. Nationally, the combined average rate would be about 48%.However, as noted, Biden’s capital gain rate hike might get whittled down in Congress. Have capital gain rates risen before?Yes, on plenty of occasions, though they also have dropped here and there. The modern-era low rate of 15% applied from 2003 to 2012. Since then, rates have risen, including that 3.8% Medicare or net investment income tax, which took effect in 2013. The new top 43.4% levy would be the highest since a rate above 70% from 1913 to 1921. Back then, taxpayers paid the same rate on capital gains as on ordinary income, explained tax researcher Wolters Kluwer. Top capital gains rates started to come down starting in 1922 “due to concerns about decreasing capital gains tax revenues,” the Tax Foundation said in a report. Since then, “Long-term capital gains have mostly been taxed at lower rates than ordinary income.”Any capital gain rate increase could discourage people from investing in assets and activities that boost the economy.Would higher taxes hurt stocks?That’s one of many unknowns, but so far investors have taken the proposal in stride.A UBS investment commentary argues that the Biden tax plan isn’t likely to exert a major headwind for the market for several reasons including the probability of Congressional pushback that could result in a tax well below 43.4% – maybe 28% plus the 3.8%.Ryan Detrick, chief market strategist for LPL Financial, examined the market impact of four prior tax hikes – in 1969, 1976, 1987 and 2013. Stocks were up an average of 6.4% over the following three months, 2.2% six months later and 4.3% 12 months later.”On the surface, you’d think higher taxes wouldn’t be a good thing, but that’s actually not reality,” he said in a commentary.UBS came to a similar conclusion. “Ultimately, other factors such as the outlook for economic growth, monetary policy and interest rates are much more powerful drivers of equity market returns and valuations,” the company said.Reach the reporter at firstname.lastname@example.org.