Whenever taxes go up there is a concern that investment will go down. Such is the case with President Biden’s plan to increase taxes on capital gains. Will higher capital gains taxes hurt your investments? It will depend on how much money you make with your investments. It will depend on what vehicles you use to invest such as through an IRA. And, it will depend on how often you buy and sell stocks and other investments. First, let’s take a look at Biden’s plan.
Biden’s Capital Gains Tax Plan
President Joe Biden’s current proposal is to nearly double capital gains taxes for taxpayers who make more than $1 million a year. The immediate concern of some investors is that they will need to sell assets sooner than they expected in order to qualify for the current rates for short and long term capital gains. This could cause a stock selloff. Alternatively, investors will look to other strategies to avoid what appear to be confiscatory tax rates.
How Will Biden’s Capital Gains Plan Affect Your Investments?
In his speech to Congress, the President proposed upping the highest capital gains tax rate to 39.6% from the current 20% for long term capital gains. He also spoke about closing “loopholes” that let high earners pay lower tax rates than the average taxpayer. It is important to remember that, as proposed, this capital gains tax increase, would only apply to about 0.3% of taxpayers. Because short term gains are taxed as ordinary income, the proposal would bring long term gains to the same level and remove any incentive to hold on to an investment more than a year in order to save on capital gains taxes. However, the current proposal only applies to those earning more than $1 million a year. If your investments don’t fall into this range you have less to worry about. And, the tax does not apply to investments that you are still holding. If you choose to sell assets gradually you could probably avoid the worst of this plan by keeping your investment income below the $1 million threshold.
Ways to Reduce Capital Gains Taxes on Your Investments
There are four practical ways to reduce capital gains taxes now and should the Biden proposal become law. The first is to space out your asset sales. By simply keeping your yearly capital gains below the $1 million threshold you come out ahead. Time your asset sales and capital gains to coincide with losses. In other words, sell your losers at the same time that you sell your winners. Because you can carry losses forward, you may be able to do this more than once. A good strategy that works for any level of capital gains is to contribute to an IRA and 401 (k). Taxes are deferred until you take money out although at that time it is taxed as ordinary income but not capitals. Do this after retirement and you will typically be paying a lower rate. And, by taking money from your retirement plan in smaller amounts over the years you will be able to take advantage of lower rates.
Why Biden’s Tax Plan Is Not Hurting Stocks
As noted by The New York Times, Biden’s proposal is not hurting stocks which are rallying. Considering that Biden also wants to raise corporate taxes, this might be surprising. However, investors seem to be more interested in earnings, current economic data, and the likelihood of an economic boom tied to infrastructure investment. As they note, when the capital gains tax has gone up before it has typically been followed by a stock market rally!
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