Can we please stop freaking out about Biden’s proposed tax increases?
My Google news feed has been inundated with articles about the upcoming capital gains tax increases from the Biden administration. The Hill warns that “Biden’s plan would nearly double the capital gains tax for the wealthy,” while financial advisors everywhere are recommending people open Roth IRAs and adopt other tax minimization strategies.
If you read the comments on these articles or on Twitter, you’ll learn that the world will end, no new companies will be built, all of our businesses will leave, and the government is going to take our hard-earned money.
The problem with the plethora of articles about the upcoming capital gains tax increase is that it is a bunch of fear-mongering and clickbait. The vast majority of Americans will not be affected, but for some reason a large segment of the population believes they are going to lose their money. The media make money from people freaking out and clicking on these articles. Financial advisors get more business as the rich flock to them for tax reduction advice.
What even are capital gains taxes?
You probably don’t really want to know what capital gains taxes are because it’s incredibly boring, so I’ll keep this short:
Capital gains taxes are those paid on gains from selling an investment that you have held for one year or longer. Only the increase is taxed, not the amount you put in. Investments held in tax-advantaged accounts such as 401ks and IRAs are exempt from capital gains taxes.
So if you buy a share stock for $100, keep it for over one year, and then sell it for $150, your capital gain would be $50. Since you owned this stock for over a year, you pay the special capital gains rate rather than higher income tax rates.
Let’s say you’re a married couple making $120,000 a year; your capital gains tax rate would be 15%. You would pay 15% x $50, which equals $7.50 of tax, and you would keep the remaining $42.50. (This example does not include any state-level capital gains taxes.)
Who would be affected by the capital gains tax increase?
The proposed capital gains tax rate hike applies to people making over $1 million in income. Fewer than 1% of Americans will end up being affected. Even then, there are numerous strategies available for legally reducing one’s tax burden.
A Fox News Business article points out that “Biden's tax proposal could cost the top 1% of US households about $300,000 annually.” I think that’s supposed to be scary, but when you think about the top 1%, $300,000 honestly doesn’t seem like that much. I thought for sure they’d be destitute Schitt’s Creek style given what a fuss people are making.
Most of the people complaining about this are either really wealthy people who want to keep their wealth or people who have been tricked into believing that this will actually affect them.
I am always surprised by the number of people railing against tax increases that won’t actually affect them. You’ve got regular people earning $40,000 a year making decisions based on their fear that the Democrats are going to take all their hard-earned money even though they will not be affected.
Smart tax planning is always a good strategy.
Of course, the financial planning industry loves news about potential tax increases because it sends the wealthy crying to them for help on lowering their tax burden, but in reality, smart tax planning is always a good strategy.
One of the most popular recommendations I’ve seen related to the increase in capital gains is to take advantage of Roth IRAs. Roth IRAs offer amazing tax benefits and everyone who can should have one. With a Roth IRA you never pay any capital gains taxes.
The only problem with this advice as it relates to the proposed capital gains tax increase is that the people affected by the change are not eligible to contribute to a Roth IRA. To qualify for a Roth IRA, you have to make less than $140,000 (single) or $208,000 for those married, filing jointly. In other words, those who make enough to see their capital gains taxes go up make WAY too much money to contribute to a Roth IRA. So while Roth IRAs are always a good move, articles recommending them to avoid potential increased capital gains taxes makes no sense.
(Of course, the rich have a little tax loophole called a backdoor Roth IRA, but there are still limits on how much you can even put in an IRA so increased capital gains taxes would be unlikely to significantly affect a person’s tax burden.)
Financial advisors are telling people to max out their retirement accounts, but find me a rich person who isn’t already doing that. If you’re that rich, you should definitely be working with an advisor who helps you invest in the most tax-efficient way. That’s not going to change.
Benefits of the tax increase
The proposed capital gains tax increase is part of the American Families Plan, designed to “build a stronger economy that does not leave anyone behind.” The plan aims to provide free preschool and community college, a national family leave program and nutrition assistance. It offers support for families struggling with survival and offers them a better chance at improving their position in life. These programs benefit all of society, from increasing the tax base to creating a more skilled workforce.
Some try to argue that an increased capital gains tax will stifle investor behavior, but really, what investor is suddenly going to stop investing in opportunities to make money just because they might make a little less money? They’re still gonna make money.
And all of this probably won’t matter anyway, because it all has to go through Congress. Even though vocal proponents of taxing the rich keep pushing for increases, the reality is that there are probably still enough wealthy Democrats who are reluctant to give such proposals their support.
It would be great if the American Families Plan did get passed because it could help so many people. Having experienced times in my life where I’ve been happy to have government assistance, I will never ever be upset to pay taxes. Because if I’m subject to higher capital gains rates (or higher tax rates in general), I will know that it is because I’m making a lot of money and that those taxes are going to support a better society in general.
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