If you're an investor, taxes on the money you make from your portfolio work against your efforts to reach your financial goals. It's critical to take advantage of the many tax breaks that are available for investors, while steering clear of the tax-planning traps lurking within the tax laws.
Yet one massive challenge in planning for your taxes is that laws tend to change. That's especially true following a presidential election, and with the 2020 campaign drawing to a close within the next three months, it's not too early to take a look at just what could happen to taxes in 2021 and beyond.
Capital gains taxes are one of the most important elements of financial planning for investors, because for those who concentrate on holding stocks for the long haul, capital gains typically make up the lion's share of total return. Both presidential candidates have plans to change the current capital gains tax system, but they would do things in much different ways. Below, we'll take a closer look at the two proposals in comparison to how things work now.
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What capital gains taxes look like in 2020
Currently, taxes on capital gains depend primarily on how long you own your stock or other investment. Gains on investments held for a year or less are treated as short-term capital gains, which get the same tax rate as ordinary income.
Hold an investment for longer than a year, though, and the rates drop considerably. As you can see below, depending on your income, you might not have to pay any tax. Others have maximum rates of 15% or 20%, which can be much lower than the corresponding ordinary income tax bracket.
Long-term capital gains tax rates for 2020 tax year
|
Filing Status |
0% Rate Applies When Taxable Income Is |
15% Rate Applies When Taxable Income Is |
20% Rate Applies When Taxable Income Is |
|---|---|---|---|
|
Single |
Less than $40,000 |
$40,000 to $441,450 |
More than $441,450 |
|
Married Filing Jointly |
Less than $80,000 |
$80,000 to $496,600 |
More than $496,600 |
|
Head of Household |
Less than $53,600 |
$53,600 to $469,050 |
More than $469,050 |
|
Married Filing Separately |
Less than $40,000 |
$40,000 to $248,300 |
More than $248,300 |
Source: IRS.
Two proposals to change capital gains taxes
Both presidential candidates have suggested changes to the way capital gains get taxed. Former Vice President Joe Biden's tax plan would take away the preferential 20% maximum capital gains rate for those with income levels about $1 million. Instead, investors would have to pay their ordinary income tax rate even on long-term capital gains. With the plan reinstating a 39.6% top tax bracket, the net impact would be to nearly double long-term capital gains liability.
The Biden plan would also eliminate one common tax break used in estate planning. Currently, heirs get what's called a "stepped-up" tax basis in assets they inherit. The result is that they don't have to pay capital gains taxes on the increased value during the deceased person's lifetime. Repeal of stepped-up basis would force more heirs to pay capital gains tax on the assets they receive from an estate.
Meanwhile, President Trump has recently called for lower capital gains taxes. He hasn't specified a particular rate-reduction target, perhaps with the understanding that he lacks authority to change rates unilaterally.
One idea that some have argued might be constitutional even without Congressional support is to index capital gains to inflation, essentially acknowledging that a portion of the long-term increase in investments is attributable not to real growth, but rather to inflation's impact on purchasing power. Under that argument, an investment that rose in value from $1,000 to $2,000 over a 20-year period might not be subject to any capital gains tax if the rise matched the rate of inflation over that time frame.
Keep your eyes on Washington
Depending on what happens in November's election, you should be ready to take quick action before the end of 2020. If it appears that changes in 2021 could hurt your particular position, then you'll want to adjust your tax strategy to take maximum advantage of current laws -- and prepare to handle whatever comes next for capital gains taxes and other tax issues.
