UNITED STATES OF AMERICA, WASHINGTON, D.C. Senator Ted Cruz (R-Texas) and Representative Warren Davidson (R-Ohio) proposed the Capital Gains Inflation Relief Act today, legislation that would ensure that an individual’s cost basis in a capital asset is treated equally to other parts of the tax law by indexing the basis for inflation. Inflation has grown by 5.4 percent since September 2020, according to the US Bureau of Labor Statistics, matching the highest rate since 2008.
Senators Thom Tillis (R-N.C.), Mike Braun (R-Ind. ), John Barrasso (R-Wyo. ), Pat Toomey (R-Pa.), Jim Inhofe (R-Okla.), and James Lankford (R-Okla.) are among the bill’s cosponsors (R-Okla.). Senator Cruz first proposed this measure in 2018.
“The Biden administration’s inflation crisis is driving prices to increase, eroding Americans’ hard-earned cash’ purchasing power.” We shield hardworking Americans from the brutal inflation tax generated by this administration’s reckless spending by indexing the cost basis of capital assets to inflation. This law would encourage individuals to save for things like a child’s college education and retirement, as well as help job creators hire more people and improve wages at a time when Americans are in desperate need. As this government attempts to destroy Americans’ wealth, I will continue to lead the battle in the Senate for a fairer, simpler tax code and economic prudence.”
“As Biden’s economy continues to deteriorate, Congress must do all possible to defend the value of Americans’ hard-earned money.” “A simple first step to protect Americans from the invisible penalty of inflation is to adjust the tax law to account for growing prices by indexing the tax basis of capital gains for inflation.”
“Senator Cruz should be applauded for bringing the Capital Gains Inflation Relief Act back to the Senate floor. Not only does this bill put an end to the unfair practice of taxing inflationary gains, but it also encourages saving, investment, and innovation, all of which will help the economy expand. It is always a good idea to index capital gains to inflation, but today, more than ever, it is critical to do so because of Joe Biden’s inflation.”
BACKGROUND
Currently, the Treasury Department calculates capital gains taxes based on the sticker price at the time of purchase, rather than the asset’s inflation-adjusted cost in today’s currency. As a result, even if the item’s value just increased and kept pace with inflation, an individual who sells a capital asset must pay tax on the gain.
The Capital Gains Inflation Relief Act indexes certain assets to inflation for the purposes of determining a gain or loss, ensuring that the capital gains tax is treated fairly in comparison to other parts of the federal tax code, such as individual income tax brackets, the standard deduction, and income thresholds for certain tax credits. Sen. Cruz’s previously filed proposal has been modified to incorporate digital assets like cryptocurrencies and non-traditional currencies (NFTs).
Does the capital gains tax take into account inflation?
The popular, erroneous belief in Washington is that the strength of the US economy is based on the willingness of the American people to spend.
Consumption has been described by commentators as the “In the United States, it is the “engine of economic growth.” They claim that in order for the economy to grow, we need to create demand.
This misguided emphasis on spending is reflected in a tax policy in the United States that discourages saving and investing.
What is true for people is also true for nations: those that spend over their means are more likely to become destitute. Those that save and invest get wealthier.
The path to a wealthier and more affluent American society is to develop a dynamic economy that encourages, rather than discourages, individuals to invest and save.
The current tax system, on the other hand, penalizes people who invest rather than spend by imposing multiple layers of additional taxes.
Congress should decrease or remove the multiple levels of double taxation on investment and saving, such as the corporate income tax, the death tax, and the capital gains tax, if it intends to boost long-term economic growth rather than inflation.
With inflation at its greatest level in 40 years, this is especially crucial today. The negative consequences of double taxation on investment are amplified by high inflation. Because capital gains aren’t indexed for inflation in the tax rules, investors can be hit with penalties even if their investments aren’t profitable.
Consider this: with the current rate of inflation, the economy’s prices will double in less than ten years. So, if you buy an asset today for $10,000 and sell it 10 years later for $20,000, you’ll have the same purchasing power as before the sale. Despite the fact that you did not gain any actual wealth from your investment, you would still have to pay tax on the $10,000 “gain” due to inflation
Policymakers could alleviate the cost of inflation and correct this unfair, anti-growth element of our tax law by indexing capital gains for inflation.
Money flowing freely between individuals who save and firms that rely on that capital to grow, compete, and provide good jobs for their employees is critical to the American economy’s dynamism. This is avoided by levying higher taxes on investors based on the rate of inflation.
Countries all across the world have been lowering taxes on savings and investment for decades, while the United States has lagged behind. Even if the United States’ capital gains taxes were indexed for inflation, they would still be expensive by worldwide standards.
The average top marginal capital gains tax rate in the Organization for Economic Cooperation and Development is 19.1 percent. The top capital gains tax rate in the United States is 29.2 percent, which includes average state taxes and the net investment income tax.
The United States was once the best place to do business and invest, and it might be again if Congress reforms the tax law to lessen the penalty for saving.
The existing tax code stifles economic growth and creates roadblocks for Americans who wish to save and invest wisely for their children’s futures. The following is an example of this “High capital gains taxes create a “lock-in effect,” in which investors keep assets for longer than they would otherwise.
To begin with, capital gains are taxed only after an individual sells or transfers an asset, so investors can defer taxes by keeping assets for extended periods of time. (Taxing is inherently charging.) “Taxing people on unrealized capital gainsthat is, gains in the value of an item before it is soldmeans taxing them on money they haven’t earned yet.)
Second, assets sold in less than a year are subject to a higher capital gains tax rate. Short-term capital gains are taxed at a higher rate, therefore people are encouraged to retain assets for at least a year to qualify for the lower rate.
Finally, capital gains taxes have a progressive rate structure that discourages taxpayers from selling assets during years when they are in the highest tax bracket.
High inflation will worsen these lock-in effects if it is not factored into the tax system, delaying or prohibiting capital from migrating to enterprises that give the best return on investment. This will deprive startups and small businesses of the investment they require, resulting in a less dynamic economy and fewer job possibilities for Americans.
Many on the left, including former President Barack Obama, advocate for higher capital gains taxes rather than indexing capital gains taxes “for the sake of justice.”
However, there is nothing fair about double taxation or taxing twice “Inflationary gains”
Raising the capital gains tax has few benefits, as it would generate little, if any, more tax income. Economists assessed that the capital gains tax rate in the United States was near or over the tax revenue-maximizing rate even before inflation surged last year. Last year, though, the Biden administration proposed a capital gains tax that would have nearly increased the top long-term capital gains tax rate.
Worse, a previous version of the “Unrealized capital gains would have been taxed under the “Build Back Better” plan, requiring individuals to pay tax before earning revenue on an asset. It would decimate business owners whose wealth is mostly held in the value of their business, in addition to being most certainly unconstitutional.
Rather of allowing the economy to suffer in the name of justice, “It’s time for politicians to eliminate government-imposed impediments that are preventing America from progressing.
Indexing capital gains for inflation would stimulate investment, protect Americans from inflation, enhance growth, and help future generations create wealth.
Why are capital gains not inflation-adjusted?
As inflation rises, the value of savers’ assets rises as well. Inflation-induced appreciation, on the other hand, does not increase actual wealth, which erodes as phantom gains are taxed.
What factors affect capital gains?
Depending on your taxable income for the year, the capital gains tax rate is either 0%, 15%, or 20%. High-earners pay a higher tax rate. Annually, the income levels are updated for inflation. (The capital gains tax rates for the tax years 2021 and 2022 can be found in the tables above.)
Is it possible to offset capital gains?
In 2021, your tax rate will be determined by whether your gain is short-term or long-term.
- Short-term earnings are taxed at your highest marginal tax rate, up to 37 percent, and, depending on your income level, may be subject to an additional 3.8 percent Medicare surtax.
- Long-term gains are given preferential treatment. Long-term gains are taxed at 15% or 20%, depending on whether the taxpayer is in the 10% or 15% band. The long-term capital gains rate for low-income taxpayers is 0%. Of course, since this is tax law, there are exceptions.
- Long-term gains on collections, such as stamps, antiques, and coins, are taxed at a rate of 28 percent unless you’re in the 10 percent, 15 percent, or 25% bracket, in which case the 10 percent, 15 percent, or 25% rate applies.
- Gains on real estate due to depreciation are taxed at 25% unless you’re in the 10% or 15% bracket (because depreciation deductions reduce your cost basis, they also boost your profit dollar for dollar).
- Because of the Kiddie Tax provisions, long-term gains from stock transactions by children under the age of 19under the age of 24 if they are studentsmight not qualify for the 0% rate. (When these restrictions apply, the gains of the kid may be taxed at the higher rates of the parents.)
What is a capital loss?
A capital loss occurs when a capital asset, such as a stock, bond, mutual fund, or real estate, is sold at a loss. Capital losses, like capital gains, are separated into short- and long-term losses by the calendar.
Can I deduct my capital losses?
Yes, however there are certain restrictions. Your investment losses are initially applied to capital gains of the same type. Short-term losses are subtracted first from short-term gains, followed by long-term losses from long-term gains. Net losses of either kind can therefore be offset against gains of the other kind.
- If you have a $2,000 short-term loss and only $1,000 in short-term gain, you can subtract the net $1,000 short-term loss from your net long-term gain (assuming you have one).
- If you have a net capital loss for the year, you can deduct up to $3,000 from other sources of income, such as your pay and interest income.
- Any excess net capital loss can be carried forward and deducted against capital gains and up to $3,000 in other types of income in later years.
- However, if you file as married filing separate, the annual net capital loss deduction maximum is only $1,500.
Are you subject to inflation taxes?
I estimated that the public held around $22.8 trillion in interest-bearing non-inflation-protected US government securities at the end of the second quarter of 2021. The wealth transfer generated by an inflation rate of 5.4 percent when businesses and households expected inflation of 2 percent is roughly 3.4 percent times the value of outstanding government debt, or about $775 billion, using 2 percent as an approximation for the average interest yield on these securities. With inflation expected to reach 5.4 percent in 2021, the inflation tax will shift $1.875 trillion in purchasing power from firms and families to the federal government in total.
Who benefits from inflation?
In general, those with a flexible income, such as businesses, dealers, merchants, and speculators, benefit from inflation because of windfall profits that result from prices rising faster than costs.
Are high taxes linked to inflation?
If exchange rate gains are taxed at the same rate as interest income, the actual return on all assets for domestic individuals falls equally. 13 These findings suggest that inflation has a significant impact on the real return to saving.
Are capital gains expected to rise in 2022?
If your income is less than $41,675 in 2022, you can take advantage of the zero percent capital gains rate. The 15 percent capital gains rate, which applies to incomes between $41,675 and $459,750, will apply to the majority of single people with investments. The 20 percent long-term capital gains rate will be applied to single filers with incomes above $459,750.
The brackets are slightly higher for married couples who file jointly, but the marriage tax penalty will affect the majority of their investment income. The good news is that married couples with earnings of $83,350 or less will remain in the 0% tax band. You have to appreciate tax-free income. Married couples earning between $83,350 and $517,200, on the other hand, will pay a capital gains tax of 15%. Those with incomes exceeding $517,200 will be subject to a 20 percent long-term capital gains tax.
Is it possible to avoid capital gains by reinvesting?
There are several tactics you can use to reduce the amount of capital gains tax you owe, regardless of what personal or investment assets you plan to sell.
Wait Longer Than a Year Before You Sell
When an asset is kept for more than a year, capital gains qualify for long-term status. If the gain is long-term, you can take advantage of the reduced capital gains tax rate.
The tax rate on long-term capital gains is determined by your filing status and the overall amount of long-term gains you have for the year. The following are the long-term capital gains tax bands for 2021:
High-income taxpayers may additionally be subject to the Net Investment Income Tax (NIIT) on capital gains, in addition to the rates mentioned above. All investment income, including capital gains, is subject to an extra 3.8 percent NIIT tax. If your income is over $200,000 for single and head of household taxpayers, or $250,000 for married couples filing a joint return, you are subject to the NIIT.
As you can see, there’s a big difference between a long-term and a short-term transaction. As an example, let’s imagine you’re a single person with a taxable income of $39,000. If you sell shares and make a $5,000 capital gain, the tax implications varies depending on whether the gain is short- or long-term:
- Short-term (held for a year or less before being sold) and taxed at 12%: $5,000 divided by 0.12 equals $600.
- Long-term (held for more than a year before being sold), 0% tax: $5,000 divided by 0.00 equals $0.
You would save $600 by holding the stock until it qualifies as long-term. Be patient because the gap between short- and long-term can be as little as one day.
Time Capital Losses With Capital Gains
Capital losses cancel out capital gains in a given year. For example, if you made a $50 profit on Stock A but lost $40 on Stock B, your net capital gain is the difference between the profits and losses – a $10 profit.
Consider the case of a stock that you sold at a loss. Consider selling some of your other valued stock, reporting the gain, and using the loss to balance the gain, lowering or eliminating your tax on the gain. But keep in mind that both transactions must take place in the same tax year.
This method may be familiar to you. Tax-loss harvesting is another name for it. Many robo-advisors, like as Betterment and Wealthfront, provide it as a feature.
Use your capital losses to lower your capital gains tax in years when you have capital gains. You must record all capital gains, but you are only allowed to deduct $3,000 in net capital losses each year. Capital losses of more than $3,000 can be carried forward to future tax years, but they can take a long time to use up if a transaction resulted in a particularly big loss.
Sell When Your Income Is Low
Your marginal tax rate impacts the rate you’ll pay on capital gains if you have short-term losses. As a result, selling capital gain assets during “lean” years may reduce your capital gains rate and save you money.
If your income is about to drop for example, if you or your spouse loses or quits a job, or if you’re ready to retire sell during a low-income year to lower your capital gains tax rate.
Reduce Your Taxable Income
Because your short-term capital gains rate is determined by your income, general tax-saving methods can assist you in qualifying for a lower rate. It’s a good idea to maximize your deductions and credits before filing your tax return. Donate money or commodities to charity, and take care of any costly medical procedures before the end of the year.
If you contribute to a traditional IRA or a 401(k), be sure you contribute the maximum amount allowed. Keep an eye out for little-known or esoteric tax deductions that can help you save money. If you want to invest in bonds, municipal bonds are a better option than corporate bonds. Municipal bond interest is tax-free in the United States, so it is not included in taxable income. There are a slew of tax benefits available. Using the IRS’s Credits & Deductions database may reveal deductions and credits you were previously unaware of.
Do a 1031 Exchange
The Internal Revenue Code section 1031 is referred to as a 1031 exchange. It permits you to sell an investment property and defer paying taxes on the profit for 180 days if you reinvest the proceeds in another “like-kind” property.
The term “like-kind property” has a broad definition. If you own an apartment building, for example, you could trade it in for a single-family rental property or even a strip mall. It cannot be exchanged for shares, a patent, company equipment, or a home that you intend to live in.
The key to 1031 exchanges is that you defer paying tax on the appreciation of the property, but you don’t get to completely avoid it. You’ll have to pay taxes on the gain you avoided by conducting a 1031 exchange when you sell the new property later.
The procedures for carrying out a 1031 exchange are complex. If you’re considering one, speak with your accountant or CPA about it, or engage with a company that specializes in 1031 exchanges. This isn’t a plan you can implement on your own.