By: Montana Timpson
Under President-elect Joe Biden’s proposed tax plan, with its likelihood of success bolstered by the recent Democratic sweep of the Senate, capital gains tax rates will rise to a speculative 39.6% for taxpayers earning more than US$1 million annually, among many other policy changes. Higher tax rates generally increase the value of tax management, inspiring a return to the start as we review the basics of capital gains taxes.
What is Capital Gains Tax?
At the core, capital gains occur when investors sell an asset for more than they initially paid for it, be it a stock, bond or other capital investment. A capital gains tax is a tax on the growth in value of the investments incurred when investors sell those assets. The total of long-term capital gains minus any capital losses is known as the “net capital gain,” which is the amount capital gains taxes are assessed on.
The U.S. capital gains tax only applies to profits from the sale of assets held for more than a year, referred to as “long-term capital gains.” In contrast, assets held for a year or less are referred to as “short-term capital gains” and are taxed as ordinary income. Only assets that have been sold, or “realized,” apply. The tax doesn’t apply to unsold investments or “unrealized capital gains,” meaning stock shares that appreciate each year do not incur capital gains taxes until they are sold, no matter how long they are held.
The tax an investor pays on realized gains held for more than a year varies according to tax rates based on income thresholds. Currently, the highest threshold is taxed at a rate of 20%, though this rate is speculated to grow to 39.6% for those at or near the US$1 million adjusted gross income hurdle under the President-elect’s proposed tax plan. Qualifications for the next threshold, where a capital gains rate of 15% applies, include a taxable income between $80,000 and $441,450 for single; $496,600 for married filing jointly, or a surviving spouse; $469,050 for head of household; and $248,300 for those who are married, filing separately. For additional details, IRS Capital Gains and Losses provides a comprehensive outline of long-term capital gains tax brackets as they currently stand.
Investment exceptions may subject investors to an additional levy, known as the net investment income tax, which imposes a current additional 3.8% of taxation on investment income — including capital gains — if modified adjusted gross income exceeds certain maximums. For more information, visit the Internal Revenue Service’s Tax Topics resource guide.
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