NOTE: This video was recorded prior to President Joe Biden’s proposal to double the Capital Gains tax on individuals earning over $1,000,000 per year. Our view is unchanged.
With proposals to eliminate the capital gains tax for people earning over $400,000 a year, it leaves us with a conundrum. Should we deliberately be taking long-term capital gains at this point in time?
Taxes are easy to manage, yet difficult to avoid. Typically strategies involve some combination of rescheduling strategies, such as: Roth conversions, tax-loss harvesting, holding onto gains so they’re long-term, deferring gains indefinitely, qualified charitable distributions from an IRA, donor advised funds, charitable remainder trusts, and even more advanced strategies such as GRATs, trusts, investing in opportunity zones. And of course rebalancing at the household level instead of the account level can reduce turnover and reduce taxes. But in most of these examples we’re managing taxes, not avoiding them. In some cases we are mitigating. The challenge is we’ve got new tax hikes on the table, and are they significant enough for us to throw some of this out the window and just take capital gains tax at 23% today for fear of a much higher marginal income tax bracket being used in the future
There’s a lot of money in selling fear. Be they blogs, 24-hour news – you name it. So the challenge is with the potential for capital gains tax hikes, or worse yet, the elimination of the capital gains tax and replacement of ordinary income tax, do we go ahead and accelerate the realization of long-term capital gains?
The challenge I see is there’s not enough political capital in Congress or the Senate – it’s too closely split to get a bill through that includes the elimination of capital gains tax, which probably explains why we hear less and less of that specific provision than we have recently. In fact, the Democrats are running into trouble right now with their own party up in New York and California, trying to eliminate the SALT caps. Which that’s the sales and local income tax, which probably every economist thought was a good law back in 2017 and every high-tax state misses significantly. Because what was it? It was a federal subsidy for high local taxes.
I’m very wary on the flip side of letting gains just run forever to avoid taxes. The problem with that strategy is if you have a growth strategy and leave it alone long enough, you’re now actually quite aggressive, especially after the last few months. So we would hate to see you actually lose more in investment portfolio value than you would have paid in taxes if you capture those gains in the course of normal rebalancing. So active tax strategies, like the ones we listed earlier, yes, including household rebalancing and judiciously capturing long-term capital gains. But deliberately realizing gains for fear of the future? No, that future is still a little far out. One of my favorite quotes is “Be careful. Don’t let the tax tail wag the dog.” We wish you the best of investing success.