75% of stock owners won't be subject to Biden's proposed capital-gains tax hike. Here's why

  • Around 3 out of every 4 U.S. stock investors wouldn't be subject to an increase in the capital-gains tax rate, according to a UBS research note.
  • That's because they bought stock in 401(k) plans, individual retirement accounts and other types of accounts not subject to the tax.
  • President Joe Biden is expected to propose raising the top federal tax rate on long-term capital gains to 39.6%, from 20%. It would apply to millionaires.

Roughly 75% of U.S. stock investors wouldn't be subject to an increase in the capital-gains tax rate due to the types of accounts they own, according to UBS.

President Joe Biden is expected to propose raising the top federal capital-gains tax to 39.6%, from the current 20%, for millionaires.

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When factoring in a Medicare surtax, the richest taxpayers would pay a total 43.4% rate on capital gains. It would apply to investment returns on stock and other assets held for over a year.

Retirement accounts

Many people would be shielded from the policy, however.

To that point, about 75% of investors own U.S. stock in accounts that aren't subject to capital-gains tax, according to a UBS research note published Friday.

They include retirement accounts like individual retirement accounts and workplace retirement plans such as 401(k) plans. Endowments and foreign investors also don't pay capital-gains tax.

"If the average American owns stock, stock mutual funds or exchange-traded funds in a qualified [retirement] plan, it doesn't have any impact," Paul Auslander, a certified financial planner and the director of financial planning at ProVise Management Group, said of Biden's expected proposal.

Remaining 25%

The remaining 25% of investors hold stock in taxable brokerage accounts that would be subject to capital-gains tax.

However, a tax hike wouldn't necessarily apply to all these taxable accounts either.

Biden's policy is expected to hit taxpayers whose income exceeds $1 million each year.

About 540,000 taxpayers had higher incomes in 2018, according to the most recent IRS data. They represent 0.3% of the 154 million people who filed a tax return for that year.

"If you're not making $1 million a year you don't have to worry about this extra tax," Auslander said.

Biden is expected to release the proposal as a way to fund spending in the upcoming American Families Plan, expected to come in at around $1 trillion.

The proposal may also change during legislative negotiations in Congress. For example, UBS expects lawmakers to pass a 28% long-term capital-gains tax rate instead of 39.6%.

Investors who are unsure whether their investment account is subject to capital gains tax can look at their account title, Auslander said.

The title for a retirement account would clearly state an investor's name with accompanying language such as "401(k)" or "IRA," he said.

Tax still owed

Americans who invest in 401(k) plans, IRAs and other retirement plans will still owe tax on the savings at some point.

Savers in traditional, pre-tax accounts owe income taxes when they withdraw the money. Those stashing money in a Roth account pay tax upfront. But they don't pay taxes on the investment earnings along the way.

"There's no tax on the gains realized within the account," said Richard Winchester, an associate professor at Seton Hall Law School.  

Similarly, others like endowments and foreign investors don't owe capital-gains taxes.

Endowments, for example, are typically held by tax-exempt organizations like universities, Winchester said.

Similarly, non-U.S. citizens who buy U.S. stock owe tax on their investment earnings. However, they do so under a tax mechanism and regime that differs from the capital-gains tax, Winchester added.

"It's divorced from the tax that Americans pay," Winchester said.

The total levy depends on treaties various countries have with the U.S.

Brokerage firms generally withhold the amount when foreign investors sell stock and other assets; the firm then pays the amount to the U.S. government.

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