Financial Planning Matters: On The Proposed Capital Gains Tax Increase

Steve Kohler, CFP®, CPFA and Nancy Kunz, CFP®, ChFC®, CLU®

President Biden proposed significant changes to the treatment of capital gains. Under the proposal, Americans with earned incomes over $1 million annually would have their capital gains tax rate nearly double from 20% to 39.6%. The capital gains tax only is applicable to the profits on the sale of assets like stocks, residences, or businesses. Importantly, this top rate will affect both short-term and long-term capital gains, which are taxed differently under current legislation. In the highest capital gains tax bracket – those earning $1 million or more on an annual basis – both short and long-term capital gains would be taxed as ordinary income.


The Impact


While the proposed tax is a material increase on the highest earning segment, those earning less than $1 million per year will be unaffected. According to analysis of Internal Revenue Service data, only 2.7% of taxpayers filing a Schedule D had adjusted gross income of $1 million or more in 2018. However, for those higher income households, or those with significant embedded gains on assets such as stocks, homes or private businesses and are planning a sale in the near future, further tax evaluation may be warranted as the tax impacts could be substantial.


In addition, the Biden tax plan would end an important estate planning strategy for wealthy Americans. His plan would end the ‘step-up’ rule that exempts beneficiaries from paying capital gains on appreciated assets like stock, real estate, the family business, etc., unless they are sold.


Under the proposal, those unrealized gains would trigger taxes upon the owner’s death. There would still be a $1 million per-person exemption plus existing exclusions for residences. More than two-thirds of U.S. families have some unrealized capital gains, but most would be covered by the $1 million exemption. Only about 3% of all families have unrealized gains above that threshold.


Mitigation Strategies


Though the tax proposal changes the landscape for asset owners, there are several strategies one can employ in order to mitigate the potential tax impact.


Key strategies include:


  • Estate and Gift Tax Exemption: Gifting assets to loved ones prior to death can reduce taxes through the estate-and-gift tax exemption.

  • Accelerated Sale: If assets have already been earmarked for future sale, selling the family business, a substantial stock holding, or a home before year end will take advantage of the currently lower tax rates.

  • Charitable Gift: Donating the appreciated assets to qualified charities may bypass capital-gains taxes, and the resulting deductions can be used to offset other income.

  • Tax-Loss Harvesting: Harvesting your investment losses if they are greater than your capital gains will offset those investment gains, and therefore reduce the ultimate tax liability.

  • Contribution to Tax Advantaged Account: Contributing appreciated assets to an IRA or 401(k) or other tax advantaged contributions like health savings accounts (HSA) can be tax-free or tax deferred and exempt from capital gains taxes.

  • Lengthen Holding Period: If there is no reason or need to sell the asset, a final strategy is to simply hold on to your investment for a longer period. This strategy generally makes financial sense, though personal situations may require otherwise. The additional time will allow gains to compound tax free and provide option value as tax rates may change again in the future.


Prior to employing any of the strategies above, please ensure the tax proposal applies to you. Regardless of your status, and if you have questions on your personal situation, your fiduciary financial advisor and/or CPA can help you assess your situation and optimize a tax strategy for your specific needs.


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Steven Kohler, CFP®, CPFA

Senior Financial Advisor

Financial Planning Chair

skohler@dbroot.com


Nancy Kunz, CFP®, ChFC®, CLU®

Financial Advisor

nkunz@dbroot.com


This material has been provided for general, informational purposes only, represents only a summary of the topics discussed, and is not suitable for everyone. The information contained herein should not be construed as personalized investment advice or recommendations. Rather, they simply reflect the opinions and views of the author. D. B. Root & Company, LLC. does not provide legal, tax, or accounting advice. Before making decisions with legal, tax, or accounting ramifications, you should consult appropriate professionals for advice that is specific to your situation. There can be no assurance that any particular strategy or investment will prove profitable. This document contains information derived from third party sources. Although we believe these third-party sources to be reliable, we make no representations as to the accuracy or completeness of any information derived from such sources, and take no responsibility therefore. This document contains certain forward-looking statements signaled by words such as "anticipate," "expect", or "believe" that indicate future possibilities. Due to known and unknown risks, other uncertainties and factors, actual results may differ materially from the expectations portrayed in such forward-looking statements. As such, there is no guarantee that the expectations, beliefs, views and opinions expressed in this document will come to pass. Information presented herein is subject to change without notice and should not be considered as a solicitation to buy or sell any security.


All investment strategies have the potential for profit or loss. Asset allocation and diversification do not ensure or guarantee better performance and cannot eliminate the risk of investment losses.


The impact of the outbreak of COVID-19 on the economy is highly uncertain. Valuations and economic data may change more rapidly and significantly than under standard market conditions. COVID-19 has and will continue based on economic forecasts to have a material impact on the US and global economy for an unknown period.

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