Even before Joe Biden stepped into the White House, some financial advisers and accountants were predicting their rich clients would act fast to take advantage of lower tax rates before a Democratic-majority Congress could raise them.
As lawmakers mull higher rates for the wealthy, new numbers from the Internal Revenue Service released this week suggest that’s exactly what’s been happening.
By late July, taxpayers reported approximately $64 billion extra in capital gains and/or capital losses compared to the same period in the prior tax season, according to IRS filing season statistics released Tuesday.
“By late July, taxpayers reported $64 billion extra in capital gains and/or capital losses compared compared to the prior tax season.”
What’s more, taxpayers worth at least $1 million — people whom Biden has his eye on especially — reported approximately $22 billion more in net capital gains and/or losses than at the same point in the previous tax season, the statistics showed.
The year-over-year increase is “dramatic” according to Richard Pomp, a professor at the University of Connecticut School of Law, who specializes in taxation. “That’s more than just the increase in the stock market would suggest.”
Just over 23 million returns reported net capital gains/losses through late July, up from around 20.7 million at the same point last year. The total amount of capital gains and/or losses were around $390.8 billion, up from approximately $326.8 billion year-over-year.
Through July, millionaires and above reported roughly $140.5 billion in combined capital gains and/or losses, up from $118.4 billion one year earlier.
The statistics do not break out the amount of the gains or the amount of losses.
People have through Oct. 15 to file income-tax returns if they have an extension; historically, more complicated returns, which also typically come from wealthier households, come later in the year.
By the end of last year, taxpayers reported approximately $794.4 billion in net capital gains/losses, IRS statistics show.
‘Increased amount of urgency’
“I think most taxpayers expect we are at a low point for the time being in terms of tax rates,” said Ross Bruch, senior vice president and senior wealth planner at Brown Brothers Harriman, a private bank for the ultra-high net worth.
Accelerating capital gains transactions may be part of the explanation for the increase, Bruch said. “I think you also have several years of market growth, and it might be a point in time when people decided to take chips off the table.”
“‘I think you also have several years of market growth, and it might be a point in time when people decided to take chips off the table.’”
— Ross Bruch, senior vice president and senior wealth planner at Brown Brothers Harriman
In his own work with clients who average between $25 million and $30 million, Bruch didn’t see the chance of higher taxes playing into stock-market investment decisions — but he did see it quicken private business sale talks for people already leaning towards selling in the coming years.
Especially during the summer, there was “an increased amount of urgency in most discussions,” Bruch said.
The IRS capital-gains statistics are a good way to peek into the strategies of the well-off at a heady time of tax-policy debate and persistent market turmoil.
With some exceptions, the highest rate for capital gains right now is 20%. That top tax rate on assets appreciating in value — be it a stock, bond, investment property, a closely-held business or otherwise — applies for individuals making at least $441,450 and married couples making above $496,600.
Another 3.8% net investment income tax applies for individuals making at least $200,000 and married couples making $250,000.
In an effort to tax wages and wealth at the same rate, Biden wants to put the top income tax rate at the Obama-era 39.6%, and also have the same 39.6% capital-gains rate apply to households making at least $1 million. Factoring in the 3.8% net investment income tax, the rich would face a 43.4% rate.
Biden’s tax hikes would pay for social spending programs, including paid leave and boosted child tax-credit payments. Sen. Joe Manchin, a centrist Democrat from West Virginia and a much-needed ‘yes’ vote, reportedly wants a “strategic pause” until 2022 on the plan.
Meanwhile, Congressional Democrats in the Ways and Means Committee have recently countered with a proposed 25% top rate for capital gains.
The tax rate for people making at least $5 million would be 31.8%, one tax expert previously noted; that’s the 25% rate, plus the 3.8% net investment income tax — in addition to a 3% surtax.
Spike in Roth IRA conversions
Other ways people act now to reduce future taxes can be found in the conversion from a traditional IRA, which uses pre-tax dollars, to a Roth IRA, which uses after-tax dollars and comes out tax-free. A conversion is a way to avoid higher tax rates when the money comes out at a future date.
In 2019, there were 22% more conversions to Roth IRAs compared to 2018, according to Fidelity Investments data. In 2020, there were 67% more conversions to Roth IRAs compared to a year earlier.
Research on the times before other tax-rate increases show people trying to make the best of the moment.
“In 2019, there were 22% more conversions to Roth IRAs compared to 2018, according to Fidelity Investments data. ”
Decades ago, the top statutory rate for capital gains climbed to 28% in 1987, up from 20%. Ahead of those changes, “realizations” — the sale triggering the capital gains taxation — climbed 60% in 1986, according researchers at the nonpartisan U.S. Congress committee Joint Committee on Taxation and the Tax Policy Center, a think tank.
Decades later, there was a 40% increase in “realizations,” ahead of the 2013 tax-policy changes that raised the rate to 20% and brought on the 3.8% net investment income tax, the researchers said.
The Biden administration and Ways and Means proposals offered no lead time before the rate hike would take effect, as a move to avoid sell offs.
In May, the Biden administration said its proposed rate hike would have been effective as of April 28, when the president unveiled the plan. The Ways and Means Committee proposal would be effective starting Sept. 13.
‘Selling pressure on an overheated market’
Wealthy Americans making transactions ahead of expected tax hikes matters, said Pomp, the University of Connecticut School of Law professor. He supports a capital gains rate hike for the rich, but policymakers still need to know it could apply “selling pressure on an overheated market.”
“When you are in this kind of environment, it doesn’t take much to send people for shelter,” he said.
On Monday, the stock market took a licking when the Dow Jones Industrial Average
fell 1.8%, the S&P 500
dropped 1.7% and the Nasdaq Composite
fell 2.2%, troubled by the debt woes of property giant China Evergrande Group.
Despite an attempted recovery of losses on Tuesday, the benchmarks mostly ended lower. The Dow and S&P 500 dropped 0.1% while the Nasdaq Composite notched a 32-point gain, or 0.2%. The markets were up slightly on Wednesday.
Bruch also said capital gains and losses reported on a person’s tax return can have wider significance because of the questions about what happens next in an economy trying to recover from a pandemic.
How are profits reinvested? Where will they be reinvested when there’s more clarity on what action the Biden administration takes? “Will they just keep their powder dry on the sidelines?” Bruch added.
All of this reflects a great deal of uncertainty, and whether any of the tax proposals swirling around will become law, Bruch said. “The increase in sales does have implications,” he said, “but we’re too in the thick of it to understand the implications just yet.”