What You Need to Know
- The Biden proposal would raise the capital gains tax rate on those earning more than $1 million.
- It would also eliminate the step-up in basis for larger estates, potentially causing heirs to incur significant capital gains taxes
- Ordinary Americans could see an impact from the proposed changes in the capital gains tax as well.
President Joe Biden’s American Families Plan includes some significant overall tax increases to fund its costs. A key part of his tax plan includes substantial increases in the capital gains tax rate for some taxpayers. Here is a rundown of what could change as far as capital gains and what this could mean for your clients.
Capital Gains Tax Basics
Capital gains taxes are assessed on assets that are sold at a profit. While this is often associated with stocks, it can also apply to the sale of real estate, a business and other types of assets. Capital gains taxes are applied only to realized gains from the sale of the assets.
Gains are the price received for the asset less your cost basis. Your cost basis includes not only the value of the asset when acquired, but also any costs to acquire the asset, such as commissions to purchase shares of a stock.
There are preferential tax rates for long-term capital gains taxes. These are realized gains for assets held for at least one year. The current long-term capital gains tax rates are 15%, 20% or 23.8% for higher income taxpayers. Assets other than stocks may have different rates for capital gains taxes.
Short-term capital gains on stocks are taxed at the taxpayer’s ordinary income tax rate, which is often higher than the preferential long-term rate.
History of the Capital Gains Tax
Since the early 1950s, the long-term capital gains rate has been lower than the top ordinary income tax rate.
In 1997, the top rate was reduced from 28% to 20%. In 2003, this was further reduced to 15%. under the Jobs and Growth Tax Relief Reconciliation Act.
The top rate increased to its current 20% in 2013. The Affordable Care Act added an extra 3.8% for the Net Investment Income Tax (NIIT) for taxpayers over certain income thresholds that became effective in 2013.
What Changes Will Biden Make to the Capital Gains Tax?
The Biden tax plan would raise the top marginal income tax rate to 39.6% from the current 37% level. For taxpayers with income above $1 million, the long-term capital gains rate would increase to 39.6% as well. When the NIIT is added in, this rate jumps to 43.4%.
In his budget plan released May 28, Biden proposed making the capital gains tax changes retroactive to April 2021 in order to prevent wealthy taxpayers from quickly selling off assets to avoid the increase.
The Biden tax plan leaves the current capital gains tax rates for those at lower income levels as is.
Another major change related to capital gains taxes proposed under the Biden tax plan is the elimination of the step-up in basis for inherited assets such as stocks, real estate and some other types of assets over a $1 million threshold.
But that proposal is already hitting opposition from Democrats in Congress, who are said to be considering allowing beneficiaries to defer the tax bill as long as they hold the assets.
Beyond repealing the step-up in basis, Biden has proposed requiring a gain to be recognized on the assets at the time of death — a proposal that tax and political analyst Andy Friedman says is unlikely to pass congressional muster.
How Will Biden’s Capital Gains Tax Affect the Wealthy?
The increased capital gains rate would reduce the amount of gains that a wealthy investor would be able to keep from selling an asset. Under the current rules, a $100,000 long-term capital gain would face a $23,800 tax bill at the federal level. With the proposed rates under the Biden tax plan, the taxes on this gain would jump to $43,400 for those above the income threshold. For a wealthy investor realizing gains on several holdings during a year, the increase in capital gains taxes could be significant.
Passage of the Biden tax plan is not a certainty, and even if it does pass, some sections may be altered. That said, there are some planning considerations for the wealthy if it does pass.
For wealthy clients who are charitably inclined, an increase of this magnitude in the capital gains tax might be a good reason to donate some of their appreciated shares to charity. This offers the benefit of a charitable deduction for the market value of the donated shares. It also removes any taxation of capital gains. This can be a very efficient way to make charitable donations under the current rules and likely under any revised rules.
How Will Biden’s Capital Gains Tax Changes Affect Ordinary Americans?
On the surface, many non-millionaires might be saying to themselves, “Who cares? This doesn’t affect me.”