How would US tax reform affect how much you pay in capital gains taxes? If you’re currently in certain tax brackets (see charts on bottom of next page), the answer could be an unwelcome surprise. In fact, under President Trump’s latest proposal (from last August), many people in most current tax brackets would see their long-term capital gains tax rates rise.
Higher-income households would be affected the most, with most seeing their long-term capital gains rate climb to 20% from 15%. Currently, for example, a married couple with $250,000 in annual taxable income pays a tax of 15% on their realized long-term capital gains; under Trump’s plan, they’d pay 20%. Even though the proposed capital gains tax rates are the same as current rates, the higher 20% rate would apply at lower income levels, which effectively increases the tax rate and the tax that most people would pay.
In case you’re wondering, the long-term capital gains tax is levied on gains from selling a mutual fund or stock that you’ve owned for over 12 months (outside of a qualified retirement account). Most people encounter these taxes when they rebalance their portfolios or sell securities to pay for upcoming expenses. Although long-term gains continue to be taxed at lower rates than most earned income (wages and salaries), they can still be a meaningful drag on investment performance.
What about the 3.8% surtax?
Although taxes on capital gains may increase, the 3.8% surtax on net investment income could be repealed. That’s the surtax that higher-income households pay to help fund healthcare under the ACA (the Affordable Care Act). The House Republicans have proposed repeal of the 3.8% tax along with the repeal of the ACA. A big question: how will replacement of the ACA be funded, if the 3.8% surtax is repealed?
US Treasury Secretary Steven Mnuchin said this past weekend that he expects US tax reform to pass Congress by August 2017. But that remains to be seen. At this point, it’s unclear which proposals, if any, will eventually make their way into the US tax code. Kristi Mathisen, Managing Director of Tax Planning at LNWM, provided her analysis last month in an article for LNWM Navigator.