New capital gains rate would increase to 39.6% for people earning $1M or more.
Last week President Biden presented his plan to increase capital gains tax rates to 39.6% for those earning $1Million or more per year. The purpose for the tax hike would be to supply the social programs and try to reduce the deficit that the United States is currently in. The existing capital gains rate for individuals in the top tax bracket is 20%. Keep in mind, this is for long term capital gains, that is investments that have been held for longer than 12 months. This applies for investments in both private and public companies, as well as fixed income and real estate. This proposal caused the stock market to drop the day it was announced due to the fact that it could drive investors to liquidate their investments ahead of the tax increase. Capital gains rates have historically been lower than ordinary income rates as a way to incentivize investments in companies to boost the overall economy. Investors are putting their money at risk and the capital gains rate is one of the incentives to do so.
One thing to keep in mind is that capital gains taxes are a form of double taxation. This money is first taxed when it is earned, then was invested and if sold for a profit would experience a capital gain. Therefore, a high income earner has already paid 37% tax on this money. So essentially for someone that is in the top tax bracket they could pay 37% when they earn the money then another 39.6% if this money is sold at a gain after being invested. While facing this tax rate one would have to ask themselves if it is worth taking the risk of investing this money in the first place. Additionally, one thing to keep in mind is this will not affect highly compensated executives due to the $1Million income threshold. Most executives’ at large corporations are not compensated up to or over $1Million through W2 income. Instead, they receive other benefits such as stock options or have the ability to reduce their income by contributing into qualified or non-qualified retirement plans.
The ultra wealthy will not be affected by this. Elon Musk, Zuckerberg, Bezos aren’t selling their shares because they do not want to give up control. This capital gains tax could end up hurting the entrepreuner that is looking to get their company started. By doubling the tax rate on a capital gain the institutions or investors that would have the excess money will have a smaller portion and less incentive to invest. This will not hurt the large venture firms or some of the top ideas but having less capital towards innovative startups could hurt the entrepreneurs in this country, especially the up and coming entrepreneurs that do not have a track record. Instead this money will be in the hands of the government for them to decide what to do with it.
Lastly, one thing to keep in mind is they could make this a retroactive tax back to January 1, 2021. Although this is not popular it has happened twice before.