Tax Rate Uncertainty: Should Investors Consider Realizing Gains Sooner Vs. Later?

Investors hate uncertainty. Today’s tax rate environment is the definition of uncertainty. This lack of clarity makes financial planning challenges. If tax rates are going up, should investors do anything today in advance of changes that may or not happen? How might possible tax increases impact existing portfolios? For appreciated assets, should investors consider paying a possibly lower tax today and re-investing in a tax-smart approach?

President Biden campaigned on increasing tax rates across a wide array of categories. The questions on investor minds are:

  • Which rates? (Ordinary income? Pass-through income? Capital gains? Dividends? Carried interest? Corporate? etc.)
  • How much?
  • What income thresholds?
  • What might be the impact to current portfolios?
  • And if tax rates are changing, then when?

But it’s not only President Biden’s campaign plan to consider. There are many (Senate, House, outside groups) contributing ideas and tax plans. The final bill will be a compromise for whatever it takes to secure 50 votes in the Senate.  

To help understand how a tax increase may impact existing portfolios, let’s focus on capital gains tax rates.

Long-term capital gains/Qualified dividends

Currently, long-term capital gains (LTCG) and qualified dividends enjoy preferential—lower—tax rates than ordinary income, short-term capital gains and non-qualified dividends for investors above a certain threshold. Then-candidate Biden campaigned on increasing these rates to equal the higher ordinary income tax rates for taxpayers making more the $1 million. That is a big number. Much of the recent discussion seems to be bringing this threshold way down.

Biden also campaigned on not increasing taxes for couples with taxable income less than $400,000. We will see where that goes in future discussions.

Let’s look at the dollar impact of increasing LTCG rates to a married couple, Joan and Joe Taxpayer. We will assume that Joan and Joe have a hypothetical stock they purchased 10 years ago for $100,000. And this stock has grown in line with the S&P 500 Index at an annualized return of 10% per year, for a gain of $160,000. (We assume no reinvesting of dividends or similar distributions that would adjust the basis.)  

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Disclosure: These views are subject to change at any time based upon market or other conditions and are current as of the date at the top of the page. The information, analysis, and opinions ...

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