The Trump administration has confirmed that the U.S. Treasury is investigating whether it has the authority to change calculation of capital gains. The 20-percent capital gains tax rate is now applied to the difference between an asset’s value when it’s purchased and sold.
The administration essentially aims to let wealthy taxpayers account for inflation when determining capital gains tax liabilities. The proposal also aims to circumvent Congress, normally the only legislative body that can change federal tax law. The New York Times reported that the move could cut capital gains tax revenues by $100 billion.
If the proposal is adopted, ripples could spread through the economy, taxation and financial planning.
As capital gains are taxed at different rates based on income levels, for instance, this proposal would favor high-income earners and taxpayers with long-held investments, according to Jean-Luc Bourdon, CPA with BrightPath Wealth Planning in Santa Barbara, Calif. “The longer an investment is held, the greater the inflation adjustment would be – particularly if it spans high inflation years such as the 1970s and 1980s,” he said.
“This measure may actually generate more income tax revenues and be beneficial to the economy,” said Jeff Fosselman, CFA and senior wealth advisor with Relative Value Partners in Northbrook, Ill.
“Since 2000, inflation (based on CPI) has averaged 2.2 percent. Assuming an annual stock growth of 6 percent, a stock bought today, applying this proposed rule, would eliminate more than a third of the capital gain recognized and taxed,” he said. “Some individuals may be incentivized to sell positions they might otherwise have kept. Further, some of these gains may then be used for gifting or for purposes other than reinvesting, which would benefit the economy.”
“I do have concerns over the long-term impact on tax rates,” said Greg Horning, a CPA and co-founder of the SC&H Group in Sparks, Md.
“Proponents will argue that indexing would have a significant positive impact on long-term investment of capital for growth, and they’re probably correct,” he said. “Whether this increase in economic activity is sufficient to generate sufficient revenue for the Treasury is difficult to handicap. And if the disparity in tax rates on capital gains and tax-deferred accounts becomes too wide, there could be an argument that long-term investment in a taxable account is preferable. The problem with this is that many investors might have difficulty keeping their hands out of that cookie jar until retirement.”
The proposal would also add to federal complexity of reporting capital gains and “there would once again be the question of, ‘Do the states follow this rule?’” said Jim Wilhelm, CPA and director of SC&H Group’s tax services. “There are a couple of code sections where taxpayers can defer gains from the sale of capital assets [such as] 1045 and 1061. If the gain is different for federal versus state, this would become a little more complex than just reporting a gain from the sale of Amazon for federal and state purposes,” Wilhelm said.
Proving the holding period for inflation adjustment might be onerous in some cases, Wilhelm added.