Recently, financial planning and investment planning discussions have focused on capital gains and the tax cost associated with them. Some clients fear that cap gains tax rates will go up with Joe Biden winning the White House and/or the US Senate flipping to Democratic control. Therefore, clients are contemplating taking gains this year to avoid any potential large increase. Those same clients immediately think they will currently pay a 20% cap gains tax rate if they do.
In order to dispel, or maybe diffuse, the cap gain rate assumption above, below is an excerpt from the IRS website that explains the rates applicable to long-term capital gain. Unless you have taxable income close to a half million dollars, your rate that applies to any long-term cap gain would be 15%, not 20%. And even then, the 20% rate only applies to the amount over the thresholds described below.
Capital Gain Tax Rates
The tax rate on most net capital gain is no higher than 15% for most individuals. Some or all net capital gain may be taxed at 0% if your taxable income is less than $78,750.
A capital gain rate of 15% applies if your taxable income is $78,750 or more but less than $434,550 for single; $488,850 for married filing jointly or qualifying widow(er); $461,700 for head of household, or $244,425 for married filing separately.
However, a net capital gain tax rate of 20% applies to the extent that your taxable income exceeds the thresholds set for the 15% capital gain rate.
So, if taxpayer already has $100,000 in taxable income and wants to sell a low basis stock position for a $300,000 long-term gain (held longer than 1 year, generally), their total taxable income would be $400,000 and therefore the tax rate on the cap gain portion of that income would be 15%. Where they are able, clients can potentially manage those gains into years to keep their rate out of the 20% zone. They can also manage charitable deductions and/or capital losses in order to bring their taxable income down, thereby keeping cap gain rates in the 15% zone.
And to dispel the tax rate increase potential/fear part above, well, we can’t really. We can’t predict what exactly will be proposed, passed, and then enacted…..or when it will be effective. But we do at least know that Biden’s platform proposal for taxes was to only increase capital gains tax rates for people making over $1 million. If that proposal sticks, the majority of people will not see a cap gain tax increase.
Clients are urged to consult with their tax advisors to determine the cost of taking such year-end gains. It may sound like a great idea or maybe it doesn’t, but it is worth exploring.
The views or opinions in this article are those of the author and do not necessarily represent the views of Washington Trust Bank or senior management. Washington Trust Bank believes that the information used in this blog was obtained from reliable sources, but we do not guarantee its accuracy. Neither the information nor any opinions expressed constitutes a solicitation for business or a recommendation of the purchase or sale of securities or commodities.
As Vice President and Senior Wealth Advisor, Greg provides financial analysis to high net worth individuals. He is the author of several articles for various publications and nonprofit organizations on estate and financial planning subjects.