Under President Joe Biden’s proposed tax increases, the top 1% of Americans could soon see their tax bills grow by about $100,000 per year.
A new report from the Institute on Taxation and Economic Policy (ITEP) finds that only the highest-earning Americans would see their taxes change if President Biden’s proposed increases to the income tax rate and capital gains rate pass. That change is concentrated amongst the top 1%, defined as those with an income over $681,600 (their average income is $2,167,700). The bottom 99% of taxpayers would see a 0% tax change, it said.
On average, the highest earners would see an increase of $104,130 in taxes, coming in at around 4.8% of their income. For those making between $276,200 to $681,600 – an average income of $404,100 – the average tax increase would be $20 a year.
Some states will be hit harder than others by tax increases
In a few states, a larger share of the population would feel the impact of proposed tax hikes. The report highlights that in five states – and the District of Columbia – a more than 1% share of the population would feel a hit.
Those are New Jersey, Massachusetts, Connecticut, California, and New York. In Massachusetts and New Jersey, 1.2% of the population would be affected by tax hikes. The wealthiest New York City residents will soon have the highest tax rate in the country regardless, per Insider’s Hillary Hoffower.
Biden’s proposals target the wealthy, but they’re not final
Beyond increases, the IRS could also get about $80 billion in funding to ramp up enforcement on the wealthiest taxpayers, as Biden is proposing. A recent study by IRS researchers and academics found that the top 1% of Americans may be hiding billions from the IRS; Biden’s increased IRS funding could raise $700 billion over a decade, which would still leave the wealthy hiding hundreds of billions.
Of course, the package still has a long way to go before becoming law. A Morgan Stanley research note looked at Biden’s proposals versus what they predict as possible, and said the corporate tax rate and rate on capital gains will ultimately come in lower. However, the income tax rate increase and IRS enforcement will likely be as Biden proposes.
“Look, I’m not out to punish anyone. But I will not add to the tax burden of the middle class of this country,” Biden said in a Wednesday speech to the joint session of Congress.
He added: “When you hear someone say that they don’t want to raise taxes on the wealthiest 1% and on corporate America – ask them: whose taxes are you going to raise instead, and whose are you going to cut?”
President Joe Biden is getting even more serious about raising taxes on the wealthy, according to a new Bloomberg report. It likely won’t look like a “wealth tax,” though.
Biden hasn’t said he’d enact a wealth tax like the one proposed by Sen. Elizabeth Warren, and instead he’s reportedly considering alterations to the tax code that would increase taxes on high earners without creating a brand-new tax that targets wealth.
Now, the deputy director of the National Economic Council, David Kamin has told Bloomberg what other tax changes are currently under discussion. One is eliminating the stepped-up basis, something that Treasury Secretary Janet Yellen has already been eyeing.
That measure has to do with inheritance, and how inherited assets are valued for tax purposes. Current law lets assets that have gained value since they were originally acquired be valued at their market price and only taxed on increase from the value at the time of inheritance – not any of the prior gains.
Also under consideration, according to Bloomberg, is increasing the tax rate on capital gains, taxing them at the same rate as the income tax.
Capital gains – profits made from selling assets like stocks – are taxed differently from income once the owner has had the asset for over a year. The rates for those gains are generally lower than the income tax. Throughout his presidency, Donald Trump mostly weighed even more cuts to capital-gains tax rates. Biden’s proposal could bring the rates up to 39% for those making the most money, a far cry from rates that currently come to around 20%. Also, wealthier Americans are exactly the type of people likelier to own assets that can be sold for a capital gain.
Finally, Biden wants to raise taxes on business.
Yellen is working toward creating a global minimum corporate tax rate, under the idea that if the US can convince most other countries to set the corporate tax rate at a certain level, Biden can raise corporate taxes without fear of multinationals leaving the country.
Growing disparity has underscored the push for a tax increase
According to Bloomberg, the “administration’s intentions” have been reinforced by the K-shaped recovery taking place throughout the pandemic in which high-income Americans have seen their jobs and wages grow, while low-income Americans experience the opposite. Biden himself used the term during a 2020 presidential debate.
Biden’s $1.9 trillion stimulus did offer some relief – and increased consumer confidence – for low-income Americans. That package was passed through reconciliation, which seems to be the most likely route forward for any Democratic tax hikes.
Tax increases – and what the wealthy are (or aren’t) paying – have been a hot topic
A new report found that the top 1% of Americans are avoiding taxes more than anticipated; they’ve been failing to report about 21% of their income.
There’s also been a more targeted push by progressives to introduce a new tax on wealth. Warren introduced a new bill that would increase taxes on the top 0.05% of households. If the measure had been in place in 2020, it would have raised $114 billion from billionaires alone.
In an interview with Bloomberg, Warren praised the American Rescue Plan and Biden’s continual advocacy for it. “There is momentum now for real change, and tax policy is a critical part of that change,” she told Bloomberg.
Warren also recently Sen. Bernie Sanders and other progressive Democrats in introducing a bill that would target corporations where CEOs are at least 50 times more than the median worker. That bill could raise up to $150 billion in 10 years.
You probably know that you have to pay taxes on just about all your income. But while the taxes on your work income is fairly straightforward – based on your tax bracket, and often automatically withheld from your paycheck – the tax on investment income can be more complex.
Not all investment income is taxed equally.
In fact, your investments are taxed at different rates, depending on the type of investment you have. Some investments are tax-exempt, some are taxed at the same rates as your ordinary income, and some benefit from preferential tax rates.
When you owe the tax can also vary. Some taxes are due only when you sell the investment at a profit. Other taxes are due when your investment pays you a distribution.
And finally, where you hold the investments matters. If the asset is in a tax-deferred account, such as an IRA, 401(k), or 529 plan, you won’t owe taxes on the earnings until you withdraw money from the account – or, depending on the type of account, ever.
See what we mean by complex? Never fear – here’s everything you need to know about the taxes on investment income, and the tax rates on different investments.
Interest income derives from the Interest earned on funds deposited in a savings or money market account, or invested in certificates of deposit, bonds or bond funds. It also applies to interest on loans you make to others.
Capital gains. Capital gains come from selling an investment at a profit. When you sell an investment for less than you paid for it, it creates a capital loss, which can offset capital gains.
Dividend income. If you own stocks, mutual funds, exchange-traded funds (ETFs), or money market funds, you may receive dividends when the board of directors of the company or fund managers decides to distribute the excess cash on hand to reward their investors.
Annuity payments. When you purchase an annuity, a contract with an insurance company, you pay over a lump sum. The insurance company invests your money, and converts it into a series of periodic payments. A portion of these payments can be taxable.
How is investment income taxed?
With so many variables, how can you estimate the tax bite on your investments? Here are the tax rates for different types of investment income.
For the most part, interest income is taxed as your ordinary income tax rate – the same rate you pay on your wages or self-employment earnings. Those rates range from 10% to 37%, based on the current (2021) tax brackets.
Some interest income is tax-exempt, though. Interest from municipal bonds is generally tax-free on your federal return; when you buy muni bonds issued by your own state, the interest is exempt from your state income tax as well.
Another exception is granted US Treasury bonds, bills, and notes, as well as US savings bonds. They are exempt from state and local taxes, though not federal taxes.
The tax rate you’ll pay on capital gains depends on how long you owned the investment before selling it.
You have a short-term capital gain if you own the asset for one year (365 days) or less before selling it. Short-term capital gains are taxed at the same rate as your ordinary income.
You have a long-term capital gain if you hold on to the investment for more than one year before selling it. Long-term gains are taxed at preferential rates, ranging from 0% to 20%, depending on your total taxable income.
Capital gains are not taxable while the funds remain within a tax-advantaged IRA, 401(k), HSA, or 529 plan.
The rate you pay on dividends from stock shares or stock funds depends on whether the dividend is qualified or unqualified.
Qualified dividends are taxed at the same rates as long-term capital gains. Unqualified dividends are taxed at the same rates as ordinary income.
To count as qualified, you must have owned the dividend-producing investment for more than 60 days during the 121-day period that started 60 days before the security’s ex-dividend date. The ex-dividend date is the date after the dividend’s record date, which is the cut-off date the company uses to determine which shareholders are eligible to receive a declared dividend.
The taxation of annuity payments is a little more complex. While you may earn interest, dividends, and capital gains within your annuity, you don’t owe any taxes on this income until you actually start receiving your annuity payouts. You only have tax due on the sums you receive each year.
What you owe also depends on whether you purchased the annuity with pre-tax or after-tax dollars. If you purchase an annuity with pre-tax dollars (by rolling over money from your 401(k) or IRA), payments from the annuity are fully taxable.
But if you purchase an annuity with after-tax dollars – that is, you didn’t use retirement account money, you only pay taxes on the earnings portion of your withdrawal. The rest is considered a return of principal (the original lump sum you paid into the annuity).
When you receive your 1099-R from your insurance company showing your annuity payouts for the year, it will indicate the total taxable amount of your annuity income.
Whether you pay tax on 100% of the annuity payments or only the earnings portion of your withdrawal, all annuity payments are taxed at the ordinary-income rate.
How do I avoid taxes on investment income?
Most investment income is taxable, but there are a few strategies for avoiding – or at least minimizing – the taxes you pay on investment returns.
Stay in a low tax bracket. Single taxpayers with taxable income of $40,400 or less in 2021 qualify for a 0% tax rate on qualified dividends and capital gains. That income limit doubles for married couples filing jointly. If you can take advantage of tax deductions that will keep your taxable income below that amount, you may be able to avoid paying taxes on a significant portion of your investment income.
Hold on to your investments. Hanging on to stocks and other investments can help ensure you take advantage of preferential rates for qualified dividends and long-term capital gains.
Invest in tax-advantaged accounts. Interest, dividends, capital gains – almost all forms of investment income are shielded from annual taxes while they remain in one of these accounts. With a traditional IRA or 401(k), the money is only taxable once you withdraw funds from the account. Money earned in a Roth IRA is never taxable, as long as you meet the withdrawal requirements. Interest income from a health savings account (HSA) or 529 plan is not taxable as long as you use the money to pay for qualified medical or educational expenses, respectively.
Harvest tax losses. Tax loss harvesting involves selling investments that are down in order to offset gains from other investments. If you have investments in your portfolio that have poor prospects for future growth, it could be worth it to sell them at a loss in order to lower your overall capital gains. Many robo-advisors and financial advisors will take care of harvesting for you, trying to net out the winners and the losers.
The financial takeaway
A few tax-exempt assets aside, investment income is taxable. And it’s taxed in two basic ways: at ordinary income rates or at a lower preferential rate, generally known as the capital gains rate.
All assets accrue income tax-free while they remain in tax-advantaged accounts.
While it’s never a good idea to make investment decisions based solely on the tax implications, it is wise to consider the tax consequences of any investment moves you make. Taxes might not be the only reason you choose one investment over another, but tax breaks can be a bonus on any well-thought-out investment strategy.