To raise more funds for his American Families Plan, President Joe Biden has proposed a plan to increase the capital gains tax rate on individuals making more than $1 million in income.
A capital gains tax is applicable to the selling of financial assets, such as real estate or stocks. The current structure calls for a 20% tax on long-term gains, which means the asset was held for more than one year.
The current tax structure is favorable to anyone that sells a long-term asset. According to Investopedia, a great source for learning about money in layman’s terms, long-term gains are currently taxed as such:
- 0% on any single person making up to $40,000 (up to $80,000 for a jointly filed couple)
- 15% on any single person making $40,000-$441,500 ($80,000-$496,600 for married couples)
- 20% on any single person making more than $441,500 ($496,600 for married couples)
Biden’s proposed plan would match the top tax rate of earned income and capital gains at 39.6% for those making in excess of $1 million. There is also a 3.8% tax dedicated towards Medicare that is already in place, meaning the top tax rate would actually equal 43.4% for capital gains.
Biden’s plan also includes taxing passed-on wealth through death to heirs. Current estate beneficiaries don’t pay taxes on these gained assets, but Biden doesn’t want these estate gains to be looked at as unrealized.
According to the University of Pennsylvania’s Wharton School, these two maneuvers could raise the U.S. more than $113 billion over the course of a decade.
While these changes may seem drastic, they would only impact a small percentage of Americans. Only about 0.3% of Americans report over $1 million in annual income.
Tax avoidance among the rich is common, however, and these changes don’t scare those high-earners.
To avoid paying taxes on realized gains, the rich simply hold onto their assets. If they need cash to make a large purchase — new real estate, for example — they will take out debt against their assets. The interest on that loan would come out to a much lower rate than it would have had they taken their capital gains and paid the ensuing tax.
Say a wealthy person that has built a real estate empire wants to add one more home to their collection. This home is worth $1 million. Instead of realizing $1 million worth of gains in assets, losing 43.4% of that to the federal government, this person could take out a loan against these assets and pay, we’ll say, a 5% interest rate. They could probably get a much lower rate than that, though.
To get that $1 million in cash, considering the money lost to tax, this person would need to sell about $1.8 million in assets. By getting a loan, they would just need to offer up assets in collateral (banks may undervalue the worth of the assets, but it would still take much less than $1.8 million to get a deal).
Paying the loan and interest back is done over time, allowing the wealthy individual to collect and pay back smaller portions at a time. If any asset liquidation is required, it would come at a much lower cost, tax-wise.
Another important consideration is that this interest can be tax-deductible, further lowering their tax bill.
The middle class has long been the segment of people keeping America afloat with its taxes. There are too many loopholes in place for the wealthy, and Biden’s plan will only close a few of them.