Seismic changes could be coming to the way America’s wealthiest investors are taxed. Under President Joe Biden’s $1.8 trillion American Families Plan, taxpayers whose incomes exceed $1 million would pay nearly twice the current long-term capital gains tax rate. While Biden’s tax proposal may have you looking to sell positions to stave off a hefty tax bill, a financial advisor can help you make sense of the potential changes and preserve your capital.
How Long-Term Capital Gains Would Be Taxed
A long-term capital gain is the profit you make from selling an asset that you’ve held for more than a year. While short-term capital gains — the money made from the sale of an asset held for less than a year — are taxed as ordinary income, long-term gains have traditionally been subject to lower tax rates.
For instance, single filers who make between $40,401 and $445,850 will pay a 15% tax on long-term capital gains in 2021. The wealthiest Americans — single filers earning $445,851 or more — are subject to a 20% long-term capital gains tax.
Here are the long-term capital gains tax rates for 2021:
Rate Single Married Filing Jointly Married Filing Separately Head of Household 0% $0 – $40,400 $0 – $80,800 $0 – $40,400 $0 – $54,100 15% $40,401 – $445,850 $80,801 – $501,600 $40,401 – $250,800 $54,101 – $473,750 20% $445,851+ $501,601+ $250,801+ $473,051+
But Biden’s proposal, which needs Congressional approval, would shake things up. His plan hikes the long-term capital gains tax rate from 20% to 39.6% for households that make over $1 million per year. The proposed change would impact a sliver of Americans, about a third of the top 1% of American households, but help offset the cost of Biden’s $1.8 plan. High-income investors would also continue paying an additional 3.8% Medicare surcharge, effectively raising the top rate to 43.4%.
Announced on April 28, 2021, the American Families Plan includes $800 billion in tax credits and $1 trillion in new spending on childcare, paid family leave and education initiatives, like free community college.
To help fund the ambitious plan, the Biden Administration also wants to restore the top marginal income tax bracket to its pre-2017 level, raising income taxes from 37% to 39.6% for the wealthiest Americans.
What Financial Advisors Are Saying About Possible Changes
The American Families Plan could spell major changes for high-income earners, but some financial advisors are preaching patience to their clients. While Democrats control both chambers of Congress, their advantage in the Senate is razor thin with Vice President Kamala Harris representing the potential tie-breaking vote. Michael Collins, a financial advisor at CAPTRUST in Boston, says a “more moderate compromise” is likely to emerge given the makeup of Congress.
“While we believe capital gains tax rates are likely to go higher from here, the legislation hasn’t been finalized,” said Collins, a chartered financial analyst (CFA). “None of my clients have wanted to sell anything as a result of potential tax reform, but they are more open to realizing gains this year.”
As a result, Collins said he plans to use tax-loss harvesting to help offset potential gains. But the U.S. Department of the Treasury said the capital gains tax increase would be retroactive to the date it was announced, potentially complicating matters high-income investors.
Jim Shagawat, a certified financial planner (CFP) and partner advisor at AdvicePeriod in Paramus, New Jersey, said his clients have adapted to major shifts in tax policy over the years, but remain concerned about how the Biden plan will impact their accounts.
“High-income households, in particular, have been targeted for tax increases under Biden’s tax plan,” Shagawat said. “While recommendations may be premature, I proactively engage with my clients regarding potential future tax law changes. By being familiar with President Biden’s tax plan now, me and my clients will be positioned to take action and seize planning opportunities when changes are implemented.”
Top Tax-Efficient Investment Strategies
If you’re a high-income earner potentially impacted by the long-term capital gains tax hike, there are several strategies for minimizing your tax liability.
First, you may consider moving capital from actively managed mutual funds to exchange-traded funds (ETFs). Because ETFs track the market passively, they typically generate fewer capital gains than mutual funds and can reduce your potential tax liability.
Second, you may benefit from increasing your contributions to retirement accounts, including your 401(k) and/or individual retirement account (IRA). While these tax-advantaged accounts are subject to normal income tax rates — not capital gains taxes — contributions to traditional 401(k)s and IRAs reduce your taxable income.
Collins told SmartAsset that in light of the potential tax changes he is encouraging clients to max out IRA contributions, increase their 401(k) contributions and explore Roth IRA conversions to take advantage of tax-free growth that Roth accounts provide.
Bottom Line
Biden’s proposed tax plan could mean much larger tax bills for the wealthiest Americans when they sell long-term investments. Under the American Families Plan, households with incomes exceeding $1 million would see their long-term capital gains tax rate jump from 20% to 39.6%. Financial advisors say that could prompt a selloff, but are reminding clients that the plan is not yet law. Changes will likely be made to the proposal before it’s put to a vote on Capitol Hill. Then again, high-income investors can mitigate their potential tax liability by moving capital to more tax-efficient investments, like ETFs and retirement accounts.
Investing Tips
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There are many benefits to working with a financial advisor, who can provide asset management and financial planning, including answering questions about long-term capital gains. SmartAsset’s free matching tool can pair you with up to three local advisors in as few as five minutes. If you’re ready to find a professional, get started now.
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Are you thinking about selling stock? Consider using our capital gains tax calculator to find out how much your tax bill will be from the sale. Knowing your tax liability can help you make an informed decision about selling.
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