CRYSTAL BALL GAZING TO THE PAST
CRYSTAL BALL GAZING TO THE PAST
2 Proposals for Possible Retroactive Capital Gains Tax Hike
As a Certified Public Accounting firm, Pearson & Co. primarily serves our clients in a two-fold fashion:
- A rear-view mirror assessment of tax-related activity, and
- Forward-looking tax planning advice.
It’s important to note that all the above is conducted with a firm knowledge and understanding of the U.S. tax code for the tax year in question. Now, that frame-of-reference may be upended for upper-income taxpayers.
The following are two descriptions of proposed bumps in the capital gain rate retroactive for asset sales … one proposed by President Biden, the second more recently by the House Ways & Means Committee. We won’t speculate as to how either of those proposals may play out … just a heads-up for you to know what is being considered and how it may affect your taxes in 2021.
What Is the Capital Gains Tax?
Here’s a quick reminder. The capital gains tax applies to the profit from an investment that is incurred when the investment is sold. The emphasis is on “when the investment is sold”. At point of sale, profits (capital gains) are considered to have been “realized”, i.e. a sale price of the asset at a price higher than the original purchase price … often referred to as book value cost.
There is a further distinction between long-term and short-term capital gains. For our discussion we’ll focus on the former. Here’s a recap of this tax year’s current long-term capital gains rates.
While capital gains tax rates have fluctuated over time, they have always been a specific “known quantity” during each tax year. The current proposals point to a variance of what has been a given in past tax years.
Apparent Intent
Both Biden’s plan and that proposed by the Ways & Means Committee appear to seek wealthy Americans and corporations to pay higher taxes to help finance a $3.5 trillion budget that embraces multiple social spending programs. Included is funding for President Biden’s $1.8 trillion American Families Plan.
- Biden’s tax plan would impact long-term capital gains significantly by nearly doubling the rate for high-income investors.
- Experts agree that the Ways & Means Committee proposal is less dramatic than tax hikes proposed by President Joe Biden. As one source stated, “somewhat more taxpayer-friendly in some ways” and “a little less aggressive.” More detail in a bit.
Each proposal contains a retroactive “trigger-date” at which time the wished-for capital gains tax provisions would be initiated. An obvious question is, “Why a retroactive tax?”.
The purpose to make the tax retroactive is based on studies that show whenever a capital gains tax increase is announced, there is a rush by many investors to sell appreciated assets to realize tax savings. If a tax increase is structured so that the effective date already happened months ago, investors would clearly have no chance to unload assets at favorable tax rates before the new policy kicks in. So, a strategy to sell quickly before an anticipated new law takes effect is negated by the retroactive provision … if either proposal is enacted as currently worded.
The Proposals
Here’s a comparison of the key provisions of both proposals as they stand today.
Note: The 3.8% tax linked to the Affordable Care Act remains intact under both proposals.
Biden’s Proposal
President Biden asserts that rich taxpayers should pay as much on their stock sales and investment portfolios as they do on their income. Therefore:
- Increase the maximum income tax rate to 39.6% from its current 37%.
- Make the capital gains tax the same as the maximum income tax rate for taxpayers making $1 million or more annually.
- The new rate would go into effect retroactively on April 28, 2021 … the day the president formally presented his ideas to Congress.
Ways & Means Proposal
- Taxpayers who currently pay the 20% capital gains tax rate (see above illustration) would pay 25%.
- The new rate would go into effect retroactively on September 13, 2021 … the formal date of the bill’s introduction.
- Households earning more than $5 million pay an additional surtax of 3%.
- A transition rule provides that the preexisting statutory rate of 20% continues to apply to gains and losses for the portion of the taxable year prior to September 13, 2021.
In summary: Under Biden’s plans, millionaires would pay 43.4% … a 39.6% rate capital gains rate plus the 3.8% ACA-linked tax. Under the Ways and Means Committee proposal, a millionaire would pay 28.8% … a 25% capital gains rate, plus the 3.8% ACA-related rate. Households making more than $5 million would also have a 3% surtax, amounting to an effective 31.8% capital gains rate.
How Will American Taxpayers Be Affected
It’s clear from the foregoing that the overriding intent by legislators is to require wealthy Americans and corporations to pay higher taxes to help finance a proposed $3.5 trillion budget. While no similar story has been reported regarding the recent Ways & Means proposal, it is worth summarizing a recent Wall Street Journal article that indicates the Biden proposed retroactive capital gains tax increase may result in unintended consequences for the not-so-wealthy.
Paul Settle, a 64-year-old Kentucky man would see his savings cut in half by the proposal. Mr. Settle’s nest egg is five brick apartment buildings purchased the 27 years ago. Over the years, he has spent almost every day maintaining the grounds, repairing garbage disposals and collecting rent checks.
Mr. Settle pays himself about $75,000 a year. The idea was always to one day sell and retire off the proceeds. The President’s proposal would put the brakes to that plan.
So, the net effect of the proposal would have far-reaching effects for many American taxpayers. For example, consider homeowners (perhaps yourself) … who are a far cry from enjoying a $1 million plus income … but have profited from the surge in home prices in recent years. A home purchased 30 years ago that is today worth over $1 million could severely impact your retirement plans.
What’s Next?
Best guess is that enactment of either proposal will be a Congressional partisan battle … and likely receive little to no support from Republicans. If a final bill makes it to the Senate, Vice President Kamala Harris will need to cast the deciding vote in a 50-50 divided/balanced Senate … assuming all 50 Democrats are aboard with the measure.
And then if passed including the retroactive provision, the bill will most certainly be subject to major Constitutional scrutiny and debate.
Stay tuned!
