You might have heard about President Biden’s plan to increase the capital gains tax. Many people are worried because no one likes to pay taxes. And if you’re like me, you probably have many investments stored for retirement that you prefer to keep. Biden’s plan is only a proposal, and nothing has been implemented yet. Here’s what you should know about it.
What is a capital gains tax?
For those who don’t know, when you sell an asset – which could be stocks, bonds, real estate, jewelry and collectibles– for more than what you initially paid, it’s called capital gain. A capital gains tax is a tax on that increased value. The tax rate varies depending on your income, tax bracket and how long you held onto that asset.
Biden’s capital gains proposal
Does Biden’s capital gains tax increase affect you? Long story short, for the majority of investors, no. Biden wants to raise the capital gains tax on the wealthy – more specifically, on people who earn more than $400,000. Also, his proposal would only apply to long-term capital gains and not short-term capital gains. So, day traders, you’re safe for now.
Biden wants to increase the highest long-term capital gains rate from 20% to around 40%. This is a huge increase. However, many middle and lower-class families fall under the 0% to 15% long-term capital gains rates, which will stay the same.
How to avoid the capital gains tax
Now that you know more about Biden’s proposal, you might be thinking, “Well, I still have to pay some form of tax even without the increase. Is there a way to avoid or minimize paying these taxes?” The answer is that it depends on the asset. Unfortunately, for your $10,000 Pokémon card, there isn’t a way to avoid it. But for stocks, there is a way.
One way is to invest your money through a retirement account such as a Roth IRA or 401(k). Because these accounts are specifically for retirement, they come with tax benefits. Within these accounts, you can buy and sell stocks as many times as you want without triggering capital gains. However, with traditional 401(k)s and IRAs, you will have to pay taxes when you withdraw money from the account at retirement age.
To be eligible for a retirement account, you have to earn below a certain income. So, the rich can’t protect themselves from this tax increase, which a retirement account usually would do.
Another way to minimize the taxes you owe is through a process called tax loss harvesting, which is when you sell your securities/stocks as a loss to offset your gains. Who would have thought that losing money can actually help you save money? Losing money isn’t fun. But it’s nice to know that if you lose money in the stock market, it isn’t fully in vain.
A good problem to have
Paying more taxes is annoying because you worked hard and took the risk to make that money; the last thing you want to do is lose a portion of it. Unfortunately, there is nothing we can do if Biden’s tax bill is passed. Whether or not you like it, look at the bright side. Similar to how there is bad debt, like credit card debt, and good debt, like a mortgage, there are also good problems and bad problems. Being in a higher tax bracket is a good problem to have. We should all one day strive to have this problem, where our only worry is paying higher taxes.
For more information on capital gains tax and which rate you might have to pay, check this out.