Don't Mess With Taxes

Photo by Antoni Shkraba

Capital gains, the money made when you sell an asset that’s increased in value, have been in the tax code since the modern income tax was ratified in 1913. Back then, these earnings were taxed at a top 7 percent rate.

In 1921, an alternative top capital gains tax rate of 12.5 percent was allowed. The 5.5 percentage point hike was not that bad, though, when you compared it to the top ordinary tax rate more than a century ago of 73 pct.

Then the investment tax followed the adage that what goes up must come down. Tax rates were cut several times during the 1920s, with capital gain exclusions based on a holding period enacted in 1924. In 1942, a 50 percent exclusion was adopted, with an alternative rate of 25 percent.

Since then, financial and political considerations have prompted much jiggering with capital gains taxation. A Congressional Research Service (CRS) report on capital gains taxes covers the changes up to the time the report was issued, which was March 16, 2018.

Tax reform’s capital gains changes: That date is notable because that CRS examination was undertaken in response to capital gains tax changes in the Tax Cuts and Jobs Act (TCJA) of 2017.

While TCJA made numerous changes to individual ordinary income tax rates and deductions, the measure kept the different, and more tax advantageous, of capital gains rates already in effect.

The top ordinary income tax rate under TCJA is 37 percent, a drop from the prior 39.6 percent. The top capital gains tax rate stayed at 20 percent.

Note that this lower rate on investment earnings is for long-term capital gains. These as the profits on assets that you sell after holding them for more than a year. If you sell earlier, your capital gains are taxed at your ordinary income tax rate.

However, the massive Republican tax reform law did create new income brackets for long-term capital gains, instead of simply having the amounts apply to earnings taxed under pre-TCJA ordinary income rates. The new capital gains tax rates are indexed for inflation like their ordinary income counterparts.

Harris/Biden capital gains proposals: The TCJA’s individual tax provisions and some that apply to business filings are set to expire at the end of 2025. The Donald J. Trump campaign wants to make all of the TCJA permanent, which is no surprise since Trump signed the landmark tax law when he was in the White House.

His opponent has other ideas. And they’ve evolved a bit.

Initially, Vice President Kamala Harris generally followed the campaign plan laid out by her current boss and previous presidential nominee President Joe Biden.

As far as capital gains taxes, that included increasing the capital gains rate for Americans who make more than $1 million a year from the current top 20 percent capital gains rate to 39.6 percent. Basically, it would erase the preferable long-term capital gains tax rate and have it equal the maximum ordinary income tax rate faced by the United States’ highest earners.

But during a campaign stop in New Hampshire on Wednesday, Sept. 4, Harris announced that if elected she would push for hiking the top capital gains rate on millionaires to a lower maximum of 28 percent.

“We know when the government encourages investment, it leads to broad-based economic growth and it creates jobs,” Harris told her Granite State supporters.

Surtax remains: Of course, we’re talking taxes, so there’s always more.

The Harris capital gains proposal also appears for now to keep Biden’s 2025 fiscal year budget proposal for a 5 percent investment income surtax on U.S. taxpayers, but ups the president's $400,000 a year income threshold to $1 million.

That would push their capital gains tax rate to 33 percent for affected individuals. But it’s still notably lower than the 44.6 percent combined tax that wealthier investors would pay under Biden’s plan.

The current total rate for well-off investors is 23.8 percent. That’s from the 20 percent top capital gains rate plus the 3.8 Net Investment Income Tax, or NIIT.

This surtax is imposed on the net investment income of individuals (and some estates and trusts) with income exceeding $200,000 if single filers or $250,000 if married filing a joint tax return. The thresholds are not adjusted for inflation.

The NIIT has been in effect since Jan. 1, 2013. It was part of the Affordable Care Act, or Obamacare if you prefer, with the goal of helping fund Medicare expansion. Since the NIIT is not part of the TCJA, it will remain in the Internal Revenue Code even if the tax reform provisions expire at the end of next year.

Political possibilities of capital gains changes: All this capital gains tax talk is, of course, just campaigning at this point.

If Harris is elected, any tax changes she wants would have to go through Congress, technically starting by law in the House of Representatives.

So, that means she would need a Democratic majority in the House, and Senate, to more easily accomplish any tax changes. Or, she’d have to convince Republicans in control of either or both chambers, that her proposals are worth their support.

Either situation is, right now, unclear at best.

Current long-term capital gains tax law: All political polling and prognostication aside, for 2025 at least taxpayers making money from their capital assets will face current tax law.

For 2024 tax year planning, the following table shows the long-term capital gains tax rates and incomes that apply this tax year to returns filed in 2025.

   
The Internal Revenue Service will issue inflation adjustments to these income brackets later this fall.

Capital gains tax miscellany: Most of this post has focused on the maximum capital gains tax rate, but there also is a 0 percent tax rate for some lower-income investors.

As noted in the presidential campaign proposals, some higher earners will owe more than 20 percent on the gains from selling assets they held for more than a year. Their top rate is 23.8 percent thanks to the 3.8 percent NIIT added to the 20 percent maximum capital gains tax rate.

There are other capital gains tax rates for other holdings, like collectibles.

And there's also campaign talk about taxing unrealized capital gains. But that's for another political battle and blog post.

You also might find these items of interest:

• Biden’s proposed capital gains tax rate changes (March 13, 2024)
• Texas man charged in apparent first-ever criminal crypto capital gains tax case
• Inflation eases tax bites in 2024 on capital gains, estates, and other wealth-related income

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