For those who aren’t—but aren’t—at the top of the income pile, the rules can trigger big growth.
Instead, House tax writers proposed raising the 20% rate to 25% and retaining the 3.8% additional tax, bringing it to 28.8%. They also added a 3% additional tax for people with incomes of $5 million or more, but it would affect some Americans.
But here’s the rub: The proposed 28.8% rate would kick in a taxable income of $400,000 for single filers and $450,000 for married joint filers. This is about $50,000 less than the threshold for the current 23.8% top rate, which is $445,851 for single filers and $501,601 for married joint filers.
That’s bad news for people with income in the $400,000 to $1 million range—even if it comes from a one-time unexpected income like the sale of a home or business.
For many sellers of small businesses, the rate on their share of profits will increase from 15% to 28.8%, according to Matt Foltz, manager of BDF, a Chicago-area wealth-advising firm that works with small-business owners. Proprietors who are active in their firm usually do not owe an additional tax of 3.8% on the profit from the sale, but another provision in the House Bill will make it applicable in certain cases starting from the next year.
This is a complex area. But Mr. Foltz estimates that an owner has about $150,000 in annual taxable income from a business that sells the company at a capital gain of $1 million, on that 245,000 under the Ways and Means Bill. Dollar capital gains tax and additional taxes may be required. This is against $182,000 under current law.
These owners often have little retirement savings because they have reinvested profits into the business, says Greg Will, a planner at Bestgate Wealth Advisors in Maryland.
“The capital gains tax increase for the ultra-rich could have a significant impact on the retirement of middle-class business owners,” he says.
The proposed increase could raise taxes for sellers of long-kept homes in expensive areas such as Boston, New York City and San Francisco. If the profit exceeds the home-sellers exemption of $250,000 for single filers and $500,000 for married joint filers and the sellers’ total taxable income is above the threshold of $400,000/$450,000 .
Charlie Opler, a longtime broker based in Ridgewood, NJ, and current president of the National Association of Realtors, says that many of his firm’s clients have annual incomes of less than $400,000 and profit far more from discounts on home sales.
“I was surprised that the Ways and Means bill reached far below the president’s $1 million limit,” he says. “It will particularly affect widows and widowers, who only get the $250,000 exemption.”
The tax-rule change will be effective for transactions after September 13, the offer date, unless the seller has a binding contract. (Such cutoffs are often accompanied by changes in capital gains to prevent gamesmanship.)
Besides talking to lawmakers or trade unions, what can affected taxpayers do? Here are options to consider.
watch and wait
Neither the full House nor the Senate has acted on the Ways and Means provisions; Big changes can still happen.
For example, MPs can help home sellers by raising the proposed threshold. Less likely is an extension of the $250,000/$500,000 exemption, which was enacted in 1997 and is not indexed for inflation. They could also defer the Ways and Means proposal, as House tax writers have done with the administration’s proposal to tax capital gains on death.
gambling on the good news
It is possible, if not possible, that MPs will delay the date to take effect on 13 September. Sellers who have acted by any new cutoff date may be eligible for prior rates.
For example, President Biden’s April proposals state that sellers with earnings of $1 million or more will face a top rate of 43.4% after the introduction date. Yet some that sold after that were lucky as sales on or before September 13 now qualify for the 23.8% top rate.
Prepare to Manage Big Profits
If Congress lowers the threshold for capital gains rates, consider spreading the profit to avoid the higher brackets.
Meg Bartelt, a consultant at Flow Financial Planning near Seattle, with many clients who are women in tech, says they often make less than $400,000 a year but own the company’s stock. While a capital-gains limit of $1 million won’t complicate the plan for most, a $400,000 limit will.
These investors may want to take profits this year if it helps them stay below the $400,000 or $450,000 threshold in the future.
share your thoughts
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“If their tax rate doesn’t increase this year and they’re saved at a higher rate next year, there may be no downside to accelerating a planned sale,” she says.
Home sellers cannot spread the profit, but they can avoid taking other profits in the year of sale. They may also research every dollar spent on home improvements, as such expenses can reduce taxable benefits by increasing the cost basis of the home.
Philanthropic investors with large lump-sum gains may want to take multiple years’ deductions for less taxable income, perhaps in a donor-advised fund.
Taxes affect investment returns, but they are only one factor. Jody King, director of wealth planning at Boston’s Fiduciary Trust, is adamant: “An investment thesis, not taxes, should drive sales.”
Or as the saying goes: “Never let a dog’s tail prick a dog.”
write to Laura Saunders at [email protected]