Capital Gains Taxes Are Going Up

By :: January 24th, 2012

The top tax rate on long-term capital gains is currently 15%. That’s why Mitt Romney is spending so much time talking about his tax returns.

That revelation has set off a familiar debate about whether that low rate is appropriate. Often overlooked in these discussions, however, is the fact that the days of the 15% tax rate are numbered. As of this posting, it has only 342 left.

On January 1, 2013, capital gains taxes are scheduled to go up sharply:

First, the 2001 and 2003 tax cuts are scheduled to expire. If that happens, the regular top rate on capital gains will rise to 20%. In addition, an obscure provision of the tax code, the limitation on itemized deductions, will return in full force. That provision, known as Pease, increases effective tax rates on high-income taxpayers by reducing the value of their itemized deductions. On net, it will add another 1.2 percentage points to the effective capital gains tax rate for high-income taxpayers.

And that’s not all. The health reform legislation enacted in 2010 imposed a new tax on the net investment income of high-income taxpayers, including capital gains. That adds another 3.8 percentage points to the tax rate.

Put it all together, and the top tax rate on capital gains is scheduled to increase from 15% today to 25% on January 1. That’s a big jump. If taxpayers really believe this will happen, expect a torrent of asset selling in November and December as wealthy taxpayers take final advantage of the lower rate.

Of course, the tax cuts might get extended for all Americans, including high-income taxpayers. That’s what happened in 2010. In that case, the increase in the capital gains rate will be smaller. Because of the health reform tax, the top capital gains tax rate will increase from 15% to 18.8%. That’s still a notable increase, but would likely set off much less tax-oriented selling this year.

The only way that the top capital gains tax rate remains at 15% will be if the tax cuts are extended for high-income taxpayers and the new health reform tax gets repealed. That’s a key distinction in the election: President Barack Obama opposes those steps, while the GOP presidential candidates favor them (and some candidates would cut the capital gains tax rate even further).

11Comments

  1. Actually, the capital gains tax is heading to a de facto rate of 60 percent! « The Enterprise Blog  ::  4:28 pm on January 24th, 2012:

    […] much-needed reminder from Donald Marron over at TaxVox: First, the 2001 and 2003 tax cuts are scheduled to expire. If that happens, the regular top rate […]

  2. AMTbuff  ::  4:32 pm on January 24th, 2012:

    For anyone paying AMT, typically the affluent but not rich, the capital gains tax rate is already 22%. Reason: The phaseout of the AMT exemption adds 25 cents back to your AMT-taxable income for every dollar of capital gain. That 25 cents is taxed at 28% (26% for low-rung affluent), meaning an extra 7 cents (or 6.5 cents) of tax on the dollar of capital gain.

    This 7% rate kicker will continue, so you might want to add it to your chart. Throw in California’s 9.3% tax rate (which is not deductible under the AMT and which California’s legislature would like to increase further), and the total rate is currently 31.3%. Increasing that tax rate to 41.3% is guaranteed to depress realization of taxable gains. People will not sell unless they absolutely have to.

    The result will be an income tax under which the financially pressed (people who are forced to sell assets) pay more than the financially secure. That’s not progressive, no matter how you look at it.

    Incidentally, there are other phaseouts, notably the education tax credit, which increase the actual marginal rates on capital gains even further. One student adds 12.5%; two students add 25%. Double those percentage for single or head of household filers!

    See http://www.taxpolicycenter.org/briefing-book/background/issues/upload/Phaseouts_11.xls for a startling summary of just how these phaseouts have proliferated.

  3. Vivian Darkbloom  ::  12:16 pm on January 25th, 2012:

    I’m confused about the comments over the Pease phaseout rules.

    The first question is whether the comment was meant to include both the PEP and Pease phaseouts, or only the Pease? If only the latter, why only the latter?

    Second, would not the same effect serve to increase the effective rate of tax on dividends?

    Third, on the one hand, the comment is made that it will increase “on net” the effective income tax rate on capital gains by 1.2 percent for high income taxpayers. On the other hand, the comment is made (see graph and text) that it will increase the *marginal rate* to 25 percent. What is meant here by “on net” (on average)?

    The Pease phaseout rules would top out at about $384,000 for married couples. Thus, I view the disallowance effect as an upward sloping line that reaches a plateau of 80 percent disallowance. It seems to me that once that plateau is reached, the effective marginal rate reverts back to 23.8 percent (non-extension of tax rate for CG plus Medicare and ignoring AMT’s comment). An additional dollar of income cannot do any more damage (that is, more than 80 percent disallowance) to your itemized deduction under Pease (whether that income is capital gain or not) once the top phaseout threshold is met.

    Am I missing something about this calculation?

  4. Phillip K  ::  11:24 am on January 26th, 2012:

    It is not accurate to tally the total numbers for high-income taxpayers without qualifying for what levels of income they apply, and then lump them into a single chart. The top rate would apply only to earners making over roughly $200K (single), $220K (head of household), $240K (couples).

    Your own site has this info here: http://taxpolicycenter.org/taxtopics/Tax-Net-Long-Term-Capital-Gains.cfm

  5. right  ::  7:55 pm on January 26th, 2012:

    The problem with this analysis is that most people don’t pay capital gains on a regular basis. The wealthiest 1% own 83% of US Stocks. Furthermore, most people aren’t selling their home every year. I agree the tax code does screw the affluent more than the very wealthy, but the tax code screws everyone more than the very wealthy. A higher capital gains tax rate is the most progressive reform we can make to the tax code.

  6. How our do-nothing Congress could wipe out most of the nation’s deficit by just being themselves | Under the Mountain Bunker  ::  9:04 am on January 27th, 2012:

    […] before the 2012 elections. What that conventional wisdom ignores, however, is that Congress doesn’t have to do anything to raise the tax rate on capital gains. Doing absolutely nothing, in fact, would raise Romney’s […]

  7. Capital Gains Tax Rates: 2012 v. 2013 | My Blog  ::  7:27 am on January 28th, 2012:

    […] From TaxVox Blog: […]

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