Now there’s been a lot of talk from the President about raising the capital gain tax rate from 20% to 39.4%.
And it’s suggested that the proposed rate would be one of the highest capital gains tax hikes we’ve seen in the last 100 years.
So naturally, people have started to want to know what capital gains tax rates are, and want to know how they will be impacted.
Now, most people know about capital gains tax from the real estate they own. But, the capital gains tax extends beyond just real estate.
You have capital gains tax on:
- business investments,
- sale of a business,
…and even high-end jewelry is subject to capital gains taxes.
Now here’s the thing- when you fully understand capital gains tax then guess what?
You are able to avoid them, or at the very least strategize, to minimize your tax liability.
So in this post, what we want to do is break down what capital gains taxes are.
Then we will also share some examples with various assets, talk a little bit about what the taxes pay for, and at the end, share our opinion about the capital gains proposal.
If that sounds good to you, then keep on reading!
What is a Capital Gains Tax?
So basically, if you own an asset, and that asset appreciates in value and you sell it, you can be subject to capital gains taxes.
But the key distinction here is that you’re only subject to capital gains tax when you sell the asset. And the technical term for this is when you “realize a gain”.
But on the other hand, if you are holding stock, let’s say you have some Apple shares, and those Apple shares double in value after a period of time.
Well as long as you hold those Apple stocks, even though the value went up, you won’t pay capital gains taxes because you didn’t sell it.
And the technical term for that is “unrealized gain” because you didn’t get the money yet.
So that’s basically what capital gains tax is- you sold an asset for more than its worth. Sounds intense, but it’s really simple.
Now we want to get into some of the history with capital gains taxes, but before we do, it’s important that you know the following.
What is a Short-term Capital Gain?
The concept again is really simple. A short-term capital gain is simply when you have an asset, and you sell it in one year or less.
And so the reason why that is important to note is because short-term capital gains usually have a different tax rate that is applied to them.
As of right now, short-term capital gains are taxed as ordinary income.
So whatever tax bracket you fall in, let’s say you are in the 24% tax bracket, and then you sold an asset that went up in value…
Well on that short-term capital gain, remember it’s just the gain that is taxed, you would be taxed at 24%.
What is a Long-term Capital Gain?
Well as you probably guessed, a long-term capital gain is simply when you have an asset, and you sell it after holding longer than one year.
And like short-term capital gains, long-term capital gains have a different tax rate applied to them as well.
Right now, the long-term capital gains rate can be 0%, 15%, or 20%. It really just depends on your income and filing status.
Example of Long-term Capital Gains
As of 2020, for example, if you are single and you make $40,000 or less, then you would pay 0% long-term capital gain tax.
If you make between $40,001 to $441,450, then your long-term capital gain would be 15%.
And if you make $441,451 or more, you fall in the 20% long-term capital gains tax rate.
And of course, the income threshold goes up if your filing status is married because you have two people involved.
Regardless, you can see very clearly that there is an incentive for people to hold their assets for more than a year.
Remember that short-term capital gains are taxed at ordinary income.
So someone who’s single in 2020 making $441,451 would pay 35% if they sold in the short term, or 20% if they sold in the long term.
So now that you have a general idea of capital gains tax, let’s look at the history.
History of Capital Gains Tax
Here’s a chart going back to 1922, which is about 99 years ago.
And, as you can see the max long-term capital gains tax rate in 1922 was about 12%.
And as the economy grew and the government provided more infrastructure, the capital gains tax rates grew as well.
Then, in the 1970s is when the United States had unprecedented amounts of inflation and needed to push asset prices down.
So of course, that happening in the 1970s led to higher taxes and interest rates.
And for the last decade or so, we’ve been somewhere between 15-20% capital gains tax rates.
Now, the White House is currently proposing we raise the max capital gains tax rate up to 39.6%.
But that is if you make over $1 million dollars a year.
For those people, we edited the chart and made a slight adjustment, so you can see their tax rate would be closer to the 40% range.
According to the IRS data, that represents 0.3% of the 154 million people who filed a tax return in 2018. That’s not even 1% of the population.
So most people who own stocks, or real estate or other assets subject to a capital gain tax, should not worry at all and likely will sit somewhere between 15-20% still.
But, you probably still should know what you pay capital taxes on, so let’s talk about some assets they apply to.
And also, use an example that helps us make decisions around capital gains taxes.
This is not a complete list by any means, but let us give you 9 assets that you pay capital gains taxes on real quick.
Various Assets With A Capital Gain Tax
- Mutual Funds
- Real Estate
So that’s a lot of different assets. Now let’s take stocks as an example, run the numbers for 2020 and make some decisions together.
Decision-making Example to Avoid Capital Gains Tax
So let’s say you bought Apple stock 6 months ago and your cost basis was $10,000.
Fast forward and today, the market value of your Apple stock is $20,000. So you have a nice and even gain of $10,000 after only 6 months.
During the same year, let’s say you earned $100,000 and that puts in you the 24% tax bracket.
Just like the game show Deal or No Deal, the answer is almost impossible to predict right?
If you sell the stock then you are subject to a 24% ordinary income tax rate, which means of that $10,000, you only take $7,600.
But, if you hold the stock then you could move down to the 15% capital gains tax and keep $8,500.
On the other hand, if you hold the stock, then the stock market value could decrease, right?
Let’s say your gain is now $7,000. Well, that’s less than your gain earlier (the $7600) at the ordinary rate.
So there’s a little bit pickle here. However, what most wealthy people do is hold stocks for as long as they can.
And, only take the money when they absolutely need it, or during the year when they have no income, so they can get gains, tax-free.
They leave with the whole $10,000 and some of them are willing to hold stocks for decades to realize those gains while avoiding the tax.
What are Capital Gains Taxes Used For?
So in general, they are used to paying for basically any government service- military, social security, etc.
Specifically in 2021, what the President is proposing is that we raise capital gain taxes to do more for the lower-income and middle-income families.
While at the same time, improving the infrastructure of our country so we can make more capital gains.
Plus, we have already spent trillions of dollars in the economy and a lot of people believe that we need to pay more taxes to get out of the deficit.
Now, we’re getting into some territory that is more reserved for an economist here.
We’re not debating whether or not we should be spending trillions of dollars or not, but hopefully, this gives you an idea of why the President is proposing higher capital gain taxes in 2021.
What Are The Outcomes of High Capital Gain Taxes?
Now our opinion and perspective on the capital gains tax proposal is that we think there are likely 3 scenarios that can come our way.
1. Asset prices push higher because there is less supply.
Millionaires who want to avoid paying taxes will continue to hold their assets longer to avoid the taxes. And of course, less supply and higher demand are equal to higher prices.
2. Asset prices push lower because there is no incentive to hold assets for a long period of time.
If the capital gain tax does go up and someone has been holding an asset that they may not love, just for the tax savings…
And then that tax savings go away, then why would they hold something they don’t like? It could actually give millionaires more of a reason to go ahead and sell.
3. There is no impact at all.
Because it won’t impact the lower or middle-income class which makes up the bulk of economic activity.
And, institutional investors and millionaires have many, many options when it comes to reducing their overall tax liabilities beyond just holding their assets.
So if the President does do some kind of infrastructure planning, he’s going to need help from corporations, investors, and millionaires to actually make that happen.
And in return, we’re sure there will be tax credits and deductions that they are able to take advantage of.
So those are the 3 possible scenarios we see playing out.
And as a bias tax professional, we tend to believe that number three is the most likely scenario and what they are planning to do.
Of course, at the end of the day, for us and the average person, the biggest thing we should continue to focus on is increasing our incomes.
And, decreasing our tax liability as much as possible with the resources we have.
But if you really want to save more on your taxes, then check out our CPA tax services and let us help you.
Contact us today at 470-240-1437 so we can get started lowering your taxes.