The Biden Administration will be doubling the long-term capital gains tax rate for those earning more than $1 Million. What should you do if you think you’re going to get caught in the crosshairs? Dark Horse CEO and Co-Founder, Chase Birky, explains.
The Biden Administration will be doubling the long-term capital gains tax rate for those earning more than $1 Million. What should you do if you think you’re going to get caught in the crosshairs? Dark Horse CEO and Co-Founder, Chase Birky, explains.
This is taxes made simple. The only pod cast that gives you the tax information you need without getting too far into the weeds. So it's not often that the tax news of the week affects the stock market, but when you talk about doubling taxes for capital gains, the market tends to not love that the Biden administration indicated this week that they are aiming to raise the long-term capital gains rate. To 39.6%, which would actually be 43.4%. When you count in the net investment income tax, this would only be for taxpayers making more than a million dollars a year. And I'm not here to debate the merit of this tax increase, but I can tell you, it's going to have an impact on what the wealthy are doing with their investments. I can also tell you that there are people who would definitely not fit the stereotypical definition of wealthy that will get hit by this. Think of your middle-class everyday employee at a startup who has a one-time liquidity event when their company either gets acquired or IPOs. Even though it's a one-time event and they're not otherwise wealthy, they're going to feel this thing of this. So if you have reason to fear that you're going to be a target of this higher tax regime on your capital gains, here's what you should be considering. Number one, you might want to sell some or all of your stock before the end of 2021 to lock in the current long-term capital gains tax rates. If you go this route, you'll want to wait until later in the year, until there's more clarity about which year these new tax rates would be effective, I would warn however that you should consider more than just the tax consequences in terms of when you time the sale of your stock. If the stock went up by 50% after you sold it, you're not going to be so happy about your 20% savings on taxes. It's easy as a CPA to advise clients, to do the most tax advantage, move available to them. But sometimes you've got to put on your investment hat and say, well, taxes are an important consideration to any investment, but they're certainly not the only consideration at play. Number two, you might want to consider a truly long-term hold on your stocks to try to outlast this tax regime until a Republican takes office. Again, this is definitely the long game, but most studies out there indicate that true wealth from the stock market is attained from staying in the right stocks over a long time horizon, or as a more nuanced strategy, you could sell your shares and trenches at levels that will keep you under the $1 million Mark each year. If your income levels are otherwise low enough. So if you're at an income level below a million dollars, most years, without respect to capital gains say $700,000 in a given year, you could sell stock representing up to $300,000 in long-term capital gains without getting dinged, or you might structure a certain year to take a hundred percent bonus depreciation. If you're a business owner or some other one time significant reduction to your taxable income, to open up room, to sell an even larger chunk of your stock. Number three. If you have to sell while tax rates are high, you're going to want to keep an eye on tax deferral opportunities, such as an opportunity zone investment, which could defer the tax until such point that rates come back down to earth. There are also other strategies out there that you want to vet before a liquidity event happens. That's going to force you to sell before you have a plan in place. And one last very important consideration for entrepreneurs is to strongly consider going the C Corp route. Yes. I know that corporate tax rates are likely going to go from 21% to 28%, but many startups are either unprofitable or have NLLs do utilize when they do have a profit up until around the point where an exit could come into the picture. If the goal is an eventual exit, holding qualified small business stock in your company could save you 43.4% since the gains could be entirely tax-free. Of course, there are many nuances with how this works, like being a certain type of business and holding the stock for at least five years. But you'd be wise to get this right from the start, because in many cases you'll need to start out as a C Corp to qualify Darkhorse CPAs. We'll make sure you get this right anyway. That's it for now? Thanks for tuning into TMS or taxes made simple. If you're not into the whole brevity thing because there's teams and then there's TMS. See you next week.