President Biden recently proposed to increase the capital gains tax rates for high earners as part of The American Families Plan. Surprisingly, this proposed rate increase is slated to be effective as of the date of announcement, April 28, 2021.
The proposed change would tax long-term capital gains and qualified dividends of taxpayers with adjusted gross income (AGI) over $1 million at ordinary income tax rates, rather than at preferential capital gains rates.
Currently, the highest marginal rate for individuals is 37 percent, but the President’s budget also proposes to increase the top marginal rate to 39.6 percent. The marginal rate increase along with the 3.8-percent net investment income tax (NIIT) under IRC section 1411 could bring the total federal capital gains tax rate to 43.4 percent for the highest earners.
Notably, the tax rate increase only applies to the extent that a taxpayer’s AGI exceeds $1 million ($500,000 for married filing separately), indexed for inflation after 2022. By way of illustration, a taxpayer with $900,000 of labor income and $200,000 in preferential capital income would have $100,000 of capital income taxed at the current preferential tax rate and $100,000 taxed at ordinary income rates.
While this news may be concerning to some (particularly those who are anticipating or have already undergone major liquidity events), the tax plan will still have to be approved by both chambers of Congress (wherein it will undoubtedly undergo significant revision) before it is signed into law. Although it is uncertain what the ultimate capital gains tax rates may be and when it may take effect, it appears likely that an increase is imminent.
We recommend speaking with your tax advisor regarding questions you may have about the potential capital gains rate changes
The American Families Plan is a broad piece of legislation that may impact a number of tax code sections. If you have any questions about the proposed changes or their impact on you or your business, please contact the tax advisors at GHJ.