Biden will propose a big change in capital gains taxes: this is how they work and are calculated

Under the plan, which he intends to present during a speech to Congress on April 28, the tax rate on profits from the sale of an asset such as property or a stock, would go from 20% to 39.6% for those with income. greater than $ 1 million. one year.

Read: Some states with lower taxes won big in the 2020 census count. Are Americans moving to escape the tax collector? It also reportedly aims to end a loophole that allows people to avoid paying capital gains tax on inherited wealth, which, when combined with the higher tax rate, could raise an estimated $ 113 billion in a decade. Biden wants to use the extra income to pay for new social programs like paid family leave and free community college. As an expert on tax policy, I have been following the debate on taxing capital gains and high-income individuals for several years. To understand the implications of raising the tax rate, let’s review some of the basics. From Peter Morici: It’s time to ditch the unwieldy income tax and replace it with something much simpler. What does a capital gain do? A person’s income in a given year includes anything that can increase their overall net worth – the difference between the value of everything they own minus the debts they have. A familiar example is your paycheck, known as “earned income.” When you get paid to do a job, your earned income increases your net worth, that is, until you spend it. But the income doesn’t always come in the form of cash. When the value of something you own increases, such as a stock, your home, or your 401 (k), this type of income is known as a capital gain. For example, if you buy some stock in a company for $ 1,000 and its value appreciates to $ 2,000, the difference of $ 1,000 is an “unrealized” capital gain — that is, it has not yet been sold for a profit. While most Americans derive the vast majority of their income from wages and salaries, the wealthy tend to derive a large portion of their income from capital gains. For the highest earners in the top 0.01%, capital income represents about two-thirds of total income. How are capital gains taxed? Unlike wages, capital gains are harder to calculate and harder to tax. To tax something, the Internal Revenue Service needs to know its value. But while some assets, like stocks and mutual funds, are bought and sold frequently, so their market price is well known, others, like real estate or fine arts, don’t change hands as often. . That means that it is more difficult to know its value. Congress’s solution has been to tax capital gains only when they are realized, that is, when the asset is sold. Profit is the difference between the selling price and the original purchase price, known as the “basis.” Fortunately for most people, the largest capital gains they will make (earnings from the sale of their home) are generally tax-exempt, as are capital gains from tax-protected education or retirement savings accounts. such as 401 (k) s and 529 plans. Three-quarters of all US stocks are held in nontaxable accounts. As for taxable investments, as long as you keep them, you won’t have to pay capital gains taxes. In fact, if you die, your heirs don’t have to pay either. Under current law, when someone inherits an asset, its value is restored. This is known as the “base increase.” Simply put, the basis is the original price you paid for the asset. Let’s say you invested $ 100,000 in some stocks and held them until you died, at which point it is worth $ 300,000. If your heirs eventually sell the shares for $ 700,000, their basis would not be $ 100,000 but $ 300,000, which means they would pay taxes on only $ 400,000 in capital gains. But no one will pay taxes on the $ 200,000 in appreciation that accrued before his death. Biden’s plan would eliminate this base increase and require heirs with incomes greater than $ 1 million to pay taxes on the full amount of their capital gains. When the modern income tax was created in 1913, capital gains were taxed at the same rates as ordinary income – up to 77% in 1918 during WWI. After the war, the Conservatives began to defend the tax cuts. So Congress lowered the maximum individual tax rate to 58% in 1922 and divided capital gains from regular income, reducing the rate to 12.5%. Since then, tax rates on capital gains have changed frequently, rising as much as 40%, but they generally remain much lower than the top rate on ordinary income. It is currently 20% on income over $ 441,450 and 15% on income from $ 40,001 to $ 441,450. There is no capital gains tax on income of $ 40,000 or less. It also depends on how long you own the asset. If you buy and sell in less than a year, it is considered a short-term capital gain and is taxed at the same rate as your earned income.

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What is the impact of the capital gains tax? Supporters of relatively low rates for capital gains argue that this encourages entrepreneurship, mitigates double taxation on corporate income, and alleviates the “lockdown” effect that discourages investors from selling assets to avoid taxes. They also point out that inflation erodes the real value of capital gains. Lower fees help offset this penalty. However, other research suggests that reducing capital gains taxes does not have a significant effect on economic growth and creates other distortions that harm economic efficiency. For example, hedge fund managers take advantage of the “earned interest” loophole to classify their income as capital gains rather than wages, so they can qualify for a lower tax rate. Regardless of whether or not capital gains tax policy increases economic efficiency, tax experts know that it makes the tax system more regressive. Since capital gains are highly concentrated among high-income taxpayers, capital gains tax breaks primarily benefit the wealthy. The Tax Policy Center estimates that in 2019 taxpayers with incomes greater than $ 1 million received more than three-quarters of the benefits from lower rates, while taxpayers earning less than $ 75,000 received only 1.2%. Stephanie Leiser is a professor at the Gerald R. Ford School of Public Policy at the University of Michigan.