Hey everyone! Long time no see. Work has been pretty busy and I was running out of energy to write. Maybe I’ll be able to share what I’ve been working on soon!
I’m kind of surprised I’ve made it this long without writing something about taxes, but with tax day coming up and President Biden’s new tax proposals, I thought it’d be a good time to talk about what’s in that plan and how it will affect you, if at all.
Types of Taxes
The most relevant proposals in Biden’s tax plans are the increases in taxes on income and capital gains. Let’s first understand what these are and how they work.
Income Tax
Income tax is the tax on your wages, commissions, bonus, etc. In the US, the income tax system is bracketed, meaning you pay different amounts of tax on different portions of your income. Hopefully this chart makes it a little clearer:
If I had $80,000 in income, I would pay 10% on the first $9,875, then 12% on the next $30,250, then 22% on the final $39,875.
Capital Gains Tax
The second type of tax increase is those on capital gains, or the profit you make from selling investments. So if I buy $10 worth of stock and sell it for $30, I would pay taxes on $20 worth of capital gains. Since taxes can’t just be simple for once, there are different types of capital gains. Short term capital gains are the gains from investments that you’ve held for less than one year, and long term capital gains are from investments that you’ve held for longer than on year.
Short term capital gains are taxed just as income, so whatever gains you have will be added to your wages and then the taxes are calculated based on that table above. Long term gains, however, have a separate bracket system:
As you can see, the long term capital gains tax rate is much friendlier than the short term tax rate. For instance, if you had $30,000 in short term capital gains, you would be taxed $3,402.5 (10% of $9,875 + 12% of $20,125), whereas if you waited until the gains qualified as long term, you’d pay nothing on those gains!!!
Which taxes are increasing
We should now have a better framework to understand the President’s proposals. The ones relating to the taxes we mentioned here are:
Increasing the top income tax bracket rate from 37% to 39.6%
Increasing the top rate on long-term capital gains from 20% to 39.6%
Most people will be unaffected by this, since you’d have to have over $518,400 in income or $441,450 in capital gains, respectively, to be affected. And even further, the capital gains increase will only affect those who have over $1 million income, so it’s clear to see that the proposal is targeted at the top 1% and making the rich "pay their fair share”, as the President says.
The capital gains tax increase is the most interesting one, since a lot of the very rich make most of their money through stocks. For instance, the Google co-founders are just one of many CEOs to famously take $1 salary. By living off of the proceeds from their stocks, they can get that 20% tax bill, or maybe even 15% if they don’t take out that much, instead of the 37%.
The government is still likely to make a good amount of money from this change, though maybe not as much as it would have hoped. As mentioned above, the capital gains tax is only applied to the money made from selling investments. If people don’t sell, they don’t pay any taxes. Especially since financial ideology is so partisan and plays such a big role for both parties, it’s easy to see the extremely rich waiting a few years for a new administration to possibly come in and change everything once again.
It’s never too late to start preparing
Taxes tend to be boring and complicated, and I also just said that you likely won’t be affected by these changes, so kudos for making it this far. But that’s not to say you won’t ever be in these higher tax brackets. As the economy grows, salaries tend to increase, as you move up the chain raises will come, and it’s anyone’s guess as to what will happen to the tax rates in the future. But before we can even start thinking about how to minimize our tax bill, it’s important to know how our taxes are calculated, and hopefully I’ve clarified a bit before our returns are due next week!
"...hopefully I’ve clarified a bit before our returns are due next week!"
Austin, you clarified and then some. Insightful breakdown. I will keep this in mind when I file🍿.