With autumn approaching, it’s time to think about “harvesting” capital losses or gains from sales of securities. In addition, unfavorable tax law changes proposed in President Biden’s American Families Plan (AFP) may create an added sense of urgency for some taxpayers. (See “Proposed Tax Law Changes” at right.)

Proposed Tax Law Changes

The American Families Plan (AFP) is part of the Build Back Better Plan that was introduced by President Biden in April. The proposal contained several major tax law changes that may be relevant in the context of harvesting gains and losses and selling securities.

Here’s an example, under the AFP, the favorable 20% long-term capital gain rate for taxpayers with income more than $1 million in a tax year would increase up to 39.6% (with a corresponding increase in the top ordinary income tax rate).

The AFP retains the 3.8% net investment income tax (NIIT). This tax applies to net investment income to the extent that a taxpayer’s modified adjusted gross income (MAGI) exceeds:

  • $200,000 for single people,
  • $250,000 for married people who file jointly, and
  • $125,000 for married people who file separately.

Biden’s proposal would broaden the NIIT by applying it to many types of income greater than $400,000, rather than only investment income.

On top of the hike in capital gains, these taxpayers would face a combined tax of 43.4% at the federal level. With local and state capital gains taxes added in, some high-income individuals could face an overall capital gains tax rate of 50%.

In addition, the AFP would impose limits on a stepped-up basis for inherited assets (with certain exceptions for property donated to family-owned businesses and farms and charities). Specifically, it ends the practice for gains that exceed $1 million, or $2.5 million per couple, when combined with existing real estate exemptions. This change is designed to reduce the incentive to hold appreciated assets until after death, rather than subjecting them to capital gains tax.

Of course, these proposals have to be passed by Congress in order to become a reality. And in today’s political environment, that may be challenging. If enacted, these changes would boost the tax burden of many wealthy individuals. However, it is unclear when the proposed changes will take effect. As the parties draft and negotiate a formal bill, it is important to monitor the latest developments.

The Basics

When you sell securities and other capital assets, the losses and gains are either short-term or long-term, depending on the holding period. To qualify as a long-term loss or gain, you must have owned the securities for longer than one year (absent a special exception). For these purposes, you generally count from the day after the date you acquired the securities through the date you sell the securities.

When you file your tax return, you must deduct long-term losses from your long-term gains. Then you must deduct short-term losses from your short-term gains. Next, you must combine your net long-term gain or loss with your net short-term loss or gain. The final amount is reported on your individual tax return.

If you have a net long-term capital gain, you may benefit from a preferential tax rate. On the other hand, if you show a net loss for the year, it may offset capital gains as well as up to $3,000 of highly taxed ordinary income (such as W-2 wages). Understanding these basic concepts will be instrumental in your harvesting plans.

Long-Term Capital Gain Rates

Under current tax law, the long-term capital gains tax rate for most taxpayers is 15%. The current maximum tax rate on ordinary income is 37% (more than double the 15% long-term capital gains tax rate that most people pay).

However, the 15% rate increases to 20% for taxpayers above certain income thresholds. Before the Tax Cuts and Jobs Act (TCJA), the capital gain rates were aligned with the ordinary income tax brackets. But, under the TCJA, the rules have been changed to reflect other income thresholds indexed for inflation. For the 2021 year, the 20% rate applies to single filers with taxable income above $445,850 ($501,600 for married people who file jointly).

Conversely, some investors, such as your children, may benefit from a rock-bottom 0% long-term capital gain rate. The 0% rate in 2021 applies to single filers with taxable income under $40,400 ($80,800 for married people who file jointly). Certain high-income individuals (such as retirees) might also have a portion of their annual income taxed at the 0% rate if they have little to no employment income.

Harvest Time

To fine-tune your harvesting strategies, examine your portfolio to determine the losses and/or gains you have recognized earlier this year. Follow this basic approach:

  • If you’re showing a net gain, you can harvest capital losses from securities sales that will offset your capital gains, plus up to $3,000 of ordinary income. Any excess is carried over indefinitely.
  • If you’re showing a net loss, you can harvest capital gains from securities sales. The gains are absorbed to the amount of the loss, so you will pay zero tax on the gains. Any excess gain is taxed as either long-term or short-term gain, depending on how long you have held the security.

In particular, you may decide to sell securities that would normally produce a short-term gain that can be absorbed by a loss. Ordinarily, the gain would result in tax at your top ordinary income rate. All other things being equal, hold onto securities that will produce a long-term gain.

Similarly, if you have a short-term gain, it makes sense to realize a loss that would offset the gain, to avoid tax at those ordinary income rates.

Important: Taxes are a major financial factor when considering securities sales. But there are other relevant reasons to hold or buy certain securities.

Beyond Ordinary Income Taxes and Capital Gains 

There may be other tax ramifications resulting from securities sales. For example, if you are an upper-income investor, you may be liable for a 3.8% net investment income tax (NIIT) on top of your regular capital gains tax. Currently, the NIIT can push the overall federal tax rate on some gains to 40.8% in 2021 (37% + 3.8%). 

Depending on the tax laws in your state, you may also have to factor in state income tax considerations in the mix. Some states tax laws differ from federal tax laws.

For More Information

Contact us to help develop a plan for harvesting losses and gains that meet your needs. We are monitoring new tax law developments and can help you pivot as needed in the current tax year.

Hoberman & Lesser’s NYC accountants serve a broad cross section of businesses, ranging from publicly held companies, to private sector businesses, to individual entrepreneurs throughout New York, New Jersey, and Connecticut, and across the United States. To schedule a complimentary and confidential consultation with a member of our team, please contact us.