Capital gains taxes are levied on the profit from selling assets such as stocks, bonds, precious metals, cryptocurrencies, real estate and other property.
Though many factors determine your tax liability when selling an asset, most investors agree that the lower the tax liability, the better. However, it’s also common for government entities to propose tax increases to raise revenues and balance their budgets.
One of the most pressing issues in this election cycle is the Biden-Harris administration’s proposal to increase the capital gains tax rate Americans are currently paying.
This proposal also includes a plan to levy a minimum tax on unrealized capital gains from stocks (these are paper gains since the assets haven’t actually been sold yet), bonds or privately held companies on those with net wealth above $100 million.
[READ: How to Calculate Your Net Worth]
A Brief History of Capital Gains Taxes in America
The first federal income tax was introduced in the United States during the Civil War in 1861, but it didn’t separate capital gains from ordinary income.
The Revenue Act of 1913 included capital gains as part of taxable income following the ratification of the 16th Amendment, which ultimately set the stage for our modern-day income tax system.
Several decades later, the Revenue Act of 1978 reduced the maximum capital gains tax rate to 28%, down from 33%. Then, legislation dropped the rate to 20% in 1981. From here, the rate mainly stayed under 30%. Today, the rate is 20%.
How Could Capital Gains Tax Rates Change?
There have been recent discussions about increasing the rates for high earners to address disparities and fiscal deficits.
In his 2025 budget plan, President Joe Biden proposed, among many other tax hikes, an increase in top tax rates on capital gains income and even unrealized gains for the ultrawealthy. The proposal suggests taxing capital gains at 39.6% for households making more than $1 million.
Vice President Kamala Harris, the Democratic Presidential nominee, proposed a top capital gains tax rate of 28%. Trump hasn’t said what he proposes to do with the long-term capital gains tax.
Financial Impacts of Increasing the Capital Gains Tax Rate
A higher capital gains tax rate could impact many stakeholders in the American economy, from investors to corporations and even the federal government itself.
Higher tax rates may discourage people from investing in assets, leading to slower economic growth. They can also affect companies’ abilities to raise funds through the sale of stock, making it harder for them to expand or create new jobs.
Mark Luscombe, a principal analyst at Wolters Kluwer, believes Biden’s proposal to tax unrealized capital gains at death above a $5 million exemption ($10 million for joint filers) could send shockwaves through the stock market at some point.
“Investors who hold capital assets that they are considering selling might look at selling them in 2024 if they think they might be subject to higher capital gain tax rates in 2025,” he says.
Russell E. Gaiser III, a certified financial planner at Retirement Income Headquarters of America, has another take.
“This could have a major economic impact; it will make people think twice before liquidating an asset, leading them to hold on to assets in the short-medium term. The decreased supply could lead to increased costs for assets in the long term and, therefore, less revenue for the government,” he says.
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What to Do if the Capital Gains Tax Rate Increases
Higher capital gains tax rates can affect investors’ returns because they reduce net profit. Knowing this, savvy investors will likely look for tax-efficient investing methods, including:
— Tax-loss harvesting. This involves selling losing investments to offset the gains from profitable ones, thereby reducing taxable capital gains.
— Tax-deferred retirement accounts. Contributing to tax-deferred retirement accounts like 401(k)s or IRAs allows investors to defer paying taxes on capital gains. The investments grow tax-free within these accounts until withdrawn, typically during retirement when the investor might be in a lower tax bracket.
— Investing in exchange-traded funds. ETFs pool investors’ assets to diversify without triggering immediate capital gains tax. By swapping shares rather than selling them, investors can defer capital gains taxes while gaining exposure to a diversified portfolio.
— Invest in tax-free municipal bonds. Municipal bonds generate interest income often exempt from federal and possibly state and local taxes, particularly if the investor lives in the issuing state. This tax-favorable status makes municipal bonds attractive for investors aiming for stable, tax-efficient income.
“Finally, many wealthy shareholders may simply choose not to sell at all and hold the stock until they pass away, thereby not realizing any capital gains at all and allowing the beneficiaries to inherit the stock with the stepped-up cost basis or give to charity and take a tax deduction,” says Phillip Battin, the president and CEO of Ambassador Wealth Management.
[Related:A Guide to Tax Deductions for Charitable Donations]
Back to Basics
While it’s a good idea to stay informed about legislative changes potentially affecting capital gains taxes, investors should focus on creating a diversified portfolio that can weather any market and changes in taxation.
So, regardless of what happens with capital gains taxes, you can continue to invest wisely and according to your financial goals.
“Ultimately, a stock needs to be evaluated on its intrinsic value and whether the prospect of holding the stock or selling it and paying taxes is the most efficient use of that capital. It’s better to pay some tax on a winner than to wait until you lose all your gains and not pay taxes,” Battin says.
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Profit and Penalty: The Financial Impact of Rising Capital Gains Taxes originally appeared on usnews.com
