How to Reduce Your Capital Gains Tax Burden Under a Biden Presidency

After a competitive election, most of the dust has fallen, and Joe Biden has been declared the winner. Within moments of the race being called, the internet became a flurry of questions about the implications of a Biden presidency. Among the most popular queries were those related to money. Taxes. Income. Retirement. Deductions.

People are asking these questions because Biden made no bones about it: he is going to raise taxes for the wealthiest Americans. (He promised that taxes would not go up for those with annual salaries less than $400,000).

One of Biden’s proposed changes is to the capital gains tax.

Biden’s Proposed Changes to the Capital Gains Taxes

We are all familiar with income tax—that’s the money the government collects from the wages and salary from your job. You put in time, get paid for that time, and then give a portion back to the government.

Most are less familiar with the capital gains taxes. Capital gains taxes are government-imposed fees for increases to your net worth not from working, but from investing. It could be stock market gains. It could be interest. Or maybe you sold something for more money than you bought it for.

Capital gains taxes can be divided into two broad categories: long-term capital gains taxes and short-term capital gains taxes. The only difference is how long you hold the investment, and the dividing line is one year. If you had the investment for more than a year, it’s a long-term capital gain. If not, it’s short term. Those two are taxed differently.

Short-term capital gains are taxed at your ordinary income rate, which means you’ll be paying the tax rate of your highest tax bracket.

Long-term capital gains are taxed at a flat rate, and for most Americans, that rate is 15%.

That means if you invest in the stock market, and more a year later you sell, you pay 15% of your growth in taxes.

Under Biden’s proposed new tax plan, he would add a 3.8% tax for capital gains earned by persons with an adjusted gross income of at least $200,000 ($250,000 for married couples) and raise the capital gains rate to a flat 39.6% for those who earn at least $1,000,000. That puts the effective capital gains rate for high earners at 43.8%.

Biden’s Proposed Elimination of the “Step-up in Basis” for Capital Assets Passed on at Death

Biden has also proposed eliminating the step-up in basis that heirs to capital investments enjoy. Currently, if you make a capital purchase, like stocks, and those go up in value, they are only taxed once you sell them. And you pay taxes on the difference between the amount you purchased them for (your basis) and the amount you sell them for (the difference being the capital gain).

If you die, then your heirs take possession of those stocks at their value at your death (the new basis), and they only have to pay for any gains that accumulate between when they take possession of them (at your death) and when they sell them. That’s called the “step-up in basis.” That means there are no taxes on any of the gains you experienced during your lifetime. Under Biden’s plan, your heirs would owe taxes not just on the gains they experience, but the gains you experienced during your lifetime.

How to Exempt Yourself from Capital Gains Taxes

These capital gains taxes apply to anyone who invests without a tax-free-growth tax wrapper. There are a number of tax wrappers available as investment vehicles that determine how your investments are going to be taxed.

For example, if you invest through a 401(k), you can save in taxes today (your contributions are tax deductible), but then you will pay taxes on all your contributions, and all growth, when you withdraw it. And depending on the timing of your withdrawal, you may also pay a penalty on top of taxes. With a 401(k), even though you hold the asset for longer than a year, when you withdraw it, you are going to pay taxes on income at your ordinary income tax rate, not the capital gains tax rate. So a 401(k) as a tax wrapper recharacterizes your asset from capital gains to income, regardless of the nature of the investment. The 401(k) is not a tax-free-growth tax wrapper. All your growth is taxed.

A Roth IRA is a tax-free-growth tax wrapper. Using a Roth IRA, you can wrap your after-tax income so you can invest and never pay taxes on the growth and never pay taxes again on the contributions. When you contribute to a Roth IRA, you are exempting yourself from the capital gains taxes and will never have to pay them for the investments wrapped in the Roth.

The Roth IRA is really great for low-income earners, but it won’t help those concerned about Biden’s capital gains tax increases. Those tax increases don’t start to impact taxpayers until they have an adjusted gross income of $200,000, but those who earn $139,000 or more are disqualified from contributing to a Roth. So although a Roth IRA is a great way to avoid having to pay capital gains taxes, it is not available to those who would be affected if Biden’s proposed changes become a reality. There are other limitations of a Roth IRA (discussed here) that further limit its usefulness in avoiding capital gains taxes.

Similar to the Roth, but not plagued by its limitations, the insurance contract allows taxpayers to take after-tax income, contribute to a fund with guaranteed growth, use those funds to invest, put the returns back into the fund (without an arbitrary more-than or less-than a year cut-off), and never pay taxes on the growth.

The insurance contract is available to any insurable individual, regardless of their income. In fact, the higher your income, the more you can contribute—and the limits are far higher than the $6,000 permitted by a Roth, and in most cases are much higher than the individual wants to or can afford to contribute.

If you create an insurance contract, and you run your investments through it, it won’t much matter to you what the capital gains rate is because you won’t be subject to it.

You will have met your tax burden now when you know what the tax rate is (when you pay income tax) and you will never look back.

For more information on how this works, or if you would us to prepare an illustration that shows exactly how this will work with the particulars of your situation, drop us a line, or call us (number is below at the bottom of the website). We’d be happy to give you a no-cost, no-obligation consultation.