Capital Gains Tax Policy

With election season in full swing, we wanted to write about our favorite topic that has gotten less coverage than other hot button issues, like immigrants eating pets.

That topic is capital gains.

Our clients come to us with all kinds of capital gains tax situations. The stakes may be getting higher.

Say you bought a stock for $10, and a year later you sold it for $15. You would owe capital gains taxes on the $5 in growth. The rate you pay depends on your total income for the year (which includes your capital gains). You may owe state taxes, too.

At the federal level, capital gains are taxed at a lower rate than ordinary income to encourage investment.

Vice President Harris recently proposed a top capital gains tax rate of 28% for households earning at least $1 million. This is lower than President Biden’s proposal to raise the top rate to 39.6%, and higher than the conservative “Project 2025” plan top rate of 15%, last seen during Obama’s first term.

Would higher rates affect me?

We’re going to focus on a potential rise in tax rates rather than a potential drop, as naturally that would be of greater concern to our clients.

Below are the current tax brackets for capital gains. The Harris proposal would create another bracket starting at $1 million in income (presumably for both single filers and married couples filing jointly).

Not pictured is the sidecar “Net Investment Income tax” or NIIT of 3.8%, which kicks in above $250,000 in income for married couples. (So, the 20% rate effectively does not exist; it’s really 23.8%, and some in the 15% bracket would pay 18.8%). The Harris proposal would increase this tax to 5%, bringing the all-in top tax rate to 33%.

If the sum of your income and realized capital gains is less than $1 million, the Harris Proposal would only affect you through the increase in NIIT. Depending on your mix of income and capital gains, the most it would increase your tax bill would be by 1.2% on the capital gains.

Let’s say you are a married couple with $750,000 in W-2 income. Over the years, you have earned company stock and held onto it, accruing a $500,000 capital gain you wish to harvest to purchase a home. We’ll ignore state taxes and all income taxes and their deductions for simplicity.

Here’s how the Harris Proposal would affect your federal capital gains tax bill compared to the current rates:

Current law: 23.8% on $500,000 = $119,000

Harris Proposal: (25% on $250,000) + (33% on $250,000) = $62,500 + $82,500 = $145,000, an increase of $26,000 in taxes.

What should I do?

Right now, nothing, besides give us a call to discuss your current situation and prepare for the various possibilities. It’s likely that any changes wouldn’t come into effect until the 2026 tax year at the earliest, giving us 2025 to plan as the pathway becomes clearer.

However, we always tell our clients not to let the tax tail wag the dog. Depending on your goals, what you own, and the magnitude of the gains, potential tax hikes may not change your strategy at all.

• If capital gains tax rates are going up, on the margin, that may encourage you to pull forward the sale of appreciated assets to realize gains while rates are lower.
• If you are planning to use capital gains as part of a retirement income strategy, higher rates may change the sequencing of how you tap into assets. It may move the retirement goal post slightly further out, unless you are able to identify other ways to save money on lifetime taxes or generate higher returns.
• A higher capital gains tax makes it more important to accrue gains in assets you want to hold for the long-term. That may mean a broadly diversified ETF rather than a risky single stock.
• Higher rates may increase the benefits of direct indexing. In this strategy, investors can sell targeted losses within a diversified portfolio of individual stocks, while seeking to capture the performance of the broad market. Those losses can be carried forward indefinitely on your tax return to net out future capital gains. Therefore, if you plan to realize capital gains later, it could help to initiate such a strategy now, even before we know if rates will indeed rise.

Not all capital gains are created equal

Taxes are extremely important to investment outcomes.

Our goal is to build up capital gains in assets that serve you best for the long term. This might mean changing the face of your current taxable portfolio, while being mindful about the tax impacts, and employing strategies that seek to minimize lifetime taxes. Keeping an eye on potential policy changes can help in this endeavor.?

As a reminder, we know a lot about taxes, but we aren’t tax professionals. Introduce us to your tax advisor (or, if you don’t have one, we’ll introduce you to some of our favorites), and all of us can have a productive conversation about your capital gains strategy.?

This was prepared by Target Rock Wealth Management, Inc. (Target Rock), a federally registered investment adviser under the Investment Advisers Act of 1940. Registration as an investment adviser does not imply a certain level of skill or training.

The views expressed within are for commentary purposes only and do not take into account any individual personal, financial, legal, or tax considerations. As such, the information contained herein is not intended to be personal legal, investment, or tax advice. Nothing herein should be relied upon as such, and there is no guarantee any claims made will come to pass. Nothing in this presentation is or should be construed as a recommendation or offer to buy or sell any security. We recommend you speak with your CPA or tax professional.

An index is a portfolio of specific securities, the performance of which is often used as a benchmark in judging the relative performance of certain asset classes. An investor cannot invest directly in an index. An index does not charge management fees or brokerage expenses, and no such fees or expenses were deducted from the performance shown.

The information herein was obtained from various sources. Target Rock does not guarantee the accuracy or completeness of such information provided by third parties. The information given is as of the date indicated and believed to be reliable. Target Rock assumes no obligation to update this information, or to advise on further developments relating to it.