Kevin Lamarque | Reuters
Treasury Secretary Steve Mnuchin speaks during a TV interview at the White House in Washington, May 21, 2018.
After seeing headlines this week about a new tax proposal out of the Treasury Department, some investors might be wondering: Will I get to pay less?
Probably not.
Last month, Steven Mnuchin, the Treasury secretary, said he was considering whether his department had the power to permit Americans to factor in inflation in calculations of their capital gains taxes.
The plan already has critics who argue the change is outside of Treasury's authority and it's likely to be challenged in court.
And even if the proposal succeeds, it wouldn't reach many wallets, said Daniel Hemel, assistant professor at The University of Chicago Law School.
"For ordinary investors, it won't make much of a difference," Hemel said. "Their primary investments are in their 401(k), individual retirement accounts and life insurance, and they're not going to pay capital gains tax there anyway."
Andrew Harrer | Bloomberg | Getty Images
Half of Americans don't own stocks, while more than 80 percent of the stock market worth is concentrated in the top 10 percent of U.S. households.
In the end, nearly 90 percent of the benefits of the estimated $100 billion tax cut would go straight to the top 1 percent, according to a budget model by the University of Pennsylvania's Wharton School of Business.
For those who do pay capital gains taxes, the savings can be significant. (Taxes on capital gains are computed by subtracting the cost of the asset at time of purchase from the amount at which it was sold, and that difference is typically levied at between 15 percent and 20 percent, depending on your income).
Here's an example, provided by Hemel, of how factoring in inflation would change the calculus.
Imagine you invested $100,000 in 2000. Today that amount has grown to $400,000. Under the current rules, the capital gain would be $300,000, and you'd pay 20 percent on that (if you were a high-earner), or $60,000. Under the current proposal, however, your tax liability would drop to $50,000 because your original investment, accounting for inflation, was actually $150,000 and therefore your gain was only $250,000. So you'd pay $10,000 less in taxes.
"It dramatically lowers tax liability for investors across the country," said Ric Edelman, founder and executive chairman of Edelman Financial Services.
However, Edelman added, it would also make life a lot more complicated.
For example, mutual funds typically pay dividends quarterly, and so even if you reinvest that money, it's considered a new investment by the IRS, Edelman said. That could mean that over 20 years, you might have to track the inflation of more than 80 different investment timelines, he said. "You could call it the 'Tax Preparers Job Security Act,'" Edelman said, jokingly.
Should the change go into effect, investors who have been waiting to realize their capital gains will want to act quickly, said Hemel at The University of Chicago Law School. "If I were a private equity fund planning an exit from one of my investments, this is fantastic news," he said.
However, the change will be moot even for some wealthier investors, he said, because they never planned on paying any capital gains taxes.
Perhaps they planned to hold on to their investments until they died, in which case the inheritor of the money only pays capital gains that accrued after the person's death, known as the step-up basis. Or maybe they were going to give the money to charity, dodging capital gains while picking up a nice deduction.
There's also uncertainty around if the change would even apply to old gains, or only ones made after the provision goes into effect, said David Kamin, professor of Law at New York University School of Law.
Proponents of the proposal see indexing capital gains for inflation as a way to boost the economy and defend Americans' investments against the rising cost of living. Critics say the proposal is yet another handout to the country's richest.
"At a time when the deficit is out of control, wages are flat and the wealthiest are doing better than ever, to give the top 1 percent another advantage is an outrage and shows the Republicans' true colors," New York Sen. Chuck Schumer told The New York Times.
In light of all the drama, Hemel said, investors should not design their financial plans around the proposal.
"What Treasury giveth, Treasury can take away," Hemel said. "If there's a President Kamala Harris or Bernie Sanders in 2021, this isn't going to be around anymore."
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