Are retroactive tax increases constitutional or even fair? Until now, the capital gain tax rate was zero, 15% or 20% depending on your income. In some cases you add the Obamacare tax of 3.8%, but at worst your total tax bill is 23.8%. Long-term capital gains tax is progressive, 0% on income up to $ 40,000, 15% on $ 40,000 up to $ 441,450 and 20% on income over $ 441,451 ( in some cases add the Obamacare tax of 3.8%.
The President’s proposed 43.4% capital gain rate is only supposed to affect those earning $ 1 million or more, but if you bought a house 30 years ago that is now worth more than $ 1 million , you could be hit. Salaries may be subject to 40.8% federal tax once you include payroll taxes, but increasing the top capital gain rate from 23.8% to 43.4% would be a staggering 82% increase. If you add in state taxes like California’s current 13.3% rate, the government gets most of your gain.
A natural reaction to an impending tax hike is to sell quickly before the new law takes effect. But as the rate hike proposed is already in force for sales after April 28, 2021. It may not pass, or it may pass with a different effective date. But it’s hard to decide what to do, especially now that more proposals seem inevitable under the pending infrastructure bill.
Are you selling now, thinking you’re stuck with higher rates, or are you waiting to see? If you wait, could you miss the opportunity to sell under the old rates? What if you waited until November and the tax hike passed, but with an effective date of September or October? There is no easy answer. If the law is passed as proposed, there could also be a legal fight. Analysis by Joe Bishop-Henchman of the National Taxpayers Union Foundation’s Taxpayer Advocacy Center indicates that a retroactive increase in the capital gains tax would be unfair to taxpayers and undermine public respect for the law. He wrote that retroactive tax increases violate fundamental principles of transparency and stability and undermine the ability of taxpayers to plan their affairs.
We even wonder if retroactive taxation is constitutional. Judge Sandra Day O’Connor has previously warned that a one-year retroactivity would likely violate the due process clause. Justices Antonin Scalia and Clarence Thomas called retroactive taxation a “bait and substitution taxation”. However, these statements are not legal holdings, and it is not clear how the retroactive effective date of April 28, 2021 would hold if the law were passed in its current form with this long scope in time.
The long-term capital gains tax break applies to assets held for one year, and that includes crypto, which is also in the sights of Congress in the infrastructure bill. Of course, capital gains tax applies to your Gain not to the proceeds of your sales, so your adjusted tax base can be subtracted. Your base is your initial investment, adjusted by things like renovation costs, investment expenses, etc. Keep your receipts, which can be relevant for decades with assets like a home. The IRS always wants receipts, and if you can’t establish your base, you might have to pay taxes on it all. At least the timing is on your side as to when to sell. Traditionally, holding until death has also been an attractive tax strategy. Sure, the asset would be in your estate for estate tax purposes, but with over $ 23 million exemption for a married couple, that’s not that big of a deal. But for income tax purposes, your assets are increased upon your death.
Under current law, inherited property receives a tax base on the fair market value on death. This basic mark-up provides tax benefits to anyone who passes on valued assets, including real estate, stocks, family businesses, and more. If you repeatedly trade real estate under Section 1031 for years and die, the appreciation escapes income tax. For generations, assets held at death have been marked-up by market value when you die. Small businesses and family farms – everyone in fact – is counting on it. President Biden has said he will eventually increase the base, subject only to a $ 1 million exemption plus $ 250,000 gain on a house. Beyond that, everything would be taxed, a massive increase in tax on death. After the Democratic National Convention, Biden pledged “no new taxes” on incomes below $ 400,000 and on mom and pop businesses. Stay tuned.