Capital gains taxes are the price of making a good investment. They’re levied on profitable stock trades and real estate deals and can also apply to sales of businesses, pieces of art, collectible cars, gold or other assets. President Joe Biden has long vied to increase the capital gains rate, a goal that’s not likely to be realized before the November elections but will be a key topic of debate next year when former President Donald Trump’s tax cuts expire and Congress faces a major fight that could result in numerous tax changes.

1. How are capital gains taxed?
Investors are taxed on the difference between how much they paid for an asset and how much they sold it for. The U.S. federal rate for investments held at least one year tops out at 20%, well below the top marginal rate of 37% on wages and salaries. (Investments held for a year or less are taxed the same as wages and salaries.) As with all investments, an additional 3.8% tax applies to capital gains recorded by individuals earning at least $200,000, or married couples earning $250,000, to finance the health-insurance subsidy program known as Obamacare. And a higher 28% capital gains rate applies to transactions involving certain investments in small businesses and in collectibles such as art, antiques, stamps, wine and precious metals. States also tax capital gains but have varying approaches.

2. Who pays them?
Although anybody can have capital gains, the wealthiest of taxpayers derive the bulk of their income from capital gains on investments. Capital gains taxes don’t apply to common tax-favored retirement vehicles such as 401(k)s or individual retirement accounts; taxpayers pay ordinary rates on those gains when they withdraw money. Some lower-income taxpayers don’t pay the capital gains tax at all; individuals earning as much as $47,025 pay a 0% capital gains rate this year. Homeowners also get a break. The first $250,000 in proceeds from the sale of a primary residence is exempt from capital gains taxes for a single person, or twice that for a married couple.

3. Are U.S. rates high or low?
The 23.8% top rate (including the Obamacare add-on) ranks among the middle of the pack compared with Europe. Scandinavian countries, including Demark and Finland, have among the highest rates on investment gains. Some nations, like Switzerland, have no specific capital gains tax but tax the proceeds of investments at ordinary income rates. Others such as Belgium and Denmark exempt some stock sales held for at least a year. Canada recently made several changes to its capital gains rules to tax two-thirds of capital gains income, up from the half that’s currently taxed. The rest of the gain isn’t taxed.

4. Why are capital gains taxed lower than other income?
Proponents of the lower rate say it rewards entrepreneurship and risk-taking and encourages investors to periodically sell what they own, preventing a so-called lock-in effect, which discourages investors from selling assets in order to defer tax payments. (At least some of those proponents advocate no capital gains tax at all.) Critics say that the spread between how wages and investments are taxed can encourage rate arbitrage, creating opportunities for the wealthy to lessen their tax bills. An example is how private equity and hedge fund managers shift more of their income to be classified as investment returns instead of management fees, which are taxed as ordinary income.

5. What’s being proposed?
Biden, in his annual budget request, proposed almost doubling the rate to 39.6%—which is also the new, higher top marginal income-tax rate under his broader taxation proposal—for those earning $1 million or more. (The 3.8% surcharge for Obamacare would still be applied on top of those rates.) 

This article was provided by Bloomberg News.