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Week In Perspective: Biden Capital Gain Tax Scare Shakes Up Markets

Week In Perspective: Biden Capital Gain Tax Scare Shakes Up Markets

April 26, 2021
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The stock market finished mixed and little changed in a week marked by consolidation activity and heated tax discussions. The S&P 500 (-0.1%), Dow Jones Industrial Average (-0.5%), and Nasdaq Composite (-0.3%) finished slightly lower, while the Russell 2000 (+0.4%) closed slightly higher. 

Starting with some perspective, the S&P 500 was up 7.0% over the prior four weeks with roughly 95% of its components trading above their 200-day moving averages. Sentiment had gotten really bullish, too, giving credence to the view that the market was due for normal sideways action or a pullback. 

The market took the former route, seemingly allergic to selling interest. There was one day of noticeable selling, though, and that was on Thursday after Bloomberg reported that President Biden was planning on proposing increasing the capital gains tax rate to 39.6% from 20.0% for those earning $1 million or more.

This rate would be bumped to 43.4% when including the 3.8% tax on investment income that funds the Affordable Care Act -- and that's before state taxes are applied. Based on the facts that The New York Times published a similar report earlier in the day and that this was a part of the president's campaign, the news was viewed a convenient excuse to take profits. 

True to recent usual form, though, investors bought the dip on Friday amid optimistic undertones that comprised of speculation that negotiations could reduce the rate, strategies to work around the taxes, and observations about the market's historical ability to weather tax increases.

Despite the comeback effort, the S&P 500 energy (-1.8%), consumer discretionary (-1.2%), and utilities (-1.0%) sectors still closed lower by at least 1.0%. The health care (+1.8%) and real estate (+2.0%) sectors were the clear winners. 

In other key developments, earnings reports continued to beat expectations for the most part, weekly initial claims fell to a new post-pandemic low at 547,000 (Briefing.com consensus 600,000), and new home sales surged to its highest annual rate (1.021 million) since August 2006. 

The 10-yr yield was unchanged at 1.57% in a tight-ranged trading week. 

Last week, President Biden "dropped the mic" during a news briefing where he stated that he will be looking to propose DOUBLING the tax rate that "wealthy" Americans pay on investment returns when they sell stocks, bonds, or other assets. Let's look at what this could mean.

First, let's look at what capital gains tax is. Capital gains tax is the profit that one makes on a sale of property or an investment. When it comes to investments such as stocks, there are short-term and long-term capital gains:

  • Short-term = asset (like a stock) held for a year or less.
  • Long-term = asset (like a stock) held for a year and a day or longer.

For example, let's say you bought Apple for $90 last year on April 30, 2020 and sold it today ,on April 26, 2021, for $100. The $10 gain would be a short-term capital gain because it was held for less that a year. Short-term capital gains are taxed at your income tax rate. Long-term capital gains are taxed at 15%, or if you're in the highest tax bracket at 20%. Back to the example with the Apple stock, a short-term gain on the $10 would be taxed at your income tax rate (let's say 22%), which would mean you would owe $2.20 on that $10 gain. Instead, If you held that Apple stock to May 1, 2021 you would owe long-term capital gains of 15% (or 20% if you are in the highest tax bracket). Meaning that either way, you would have had a higher after-tax profit than you would if you realized the short-term capital gains.

Still with me here? :)

Anyway..... back to Biden. Biden is expected to unveil this proposal this week as a way to fund the American Families Plan, which would expand subsidies for child care, and make community college tuition free for all, among other things.

What is Biden defining as "wealthy":

  • Single taxpayers with more than $445,850 of income this year
  • Married couples filing jointly bumps this number up to $501,600

Biden is ultimately hoping to keep his campaigning promise of not raising taxes on Americans who earn less than $400,000 a year.

The changes to capital gains tax being proposed are for those who are in the highest tax bracket (which is also being expected to jump to 39.6% from the current 37%) who make more than $1MM in gross annual income. Those who fit this criteria could be paying capital gains, regardless of length held, of 39.6%. Also, Biden would keep the Medicare surtax in place that currently sits at 3.8% (see below for Medicare surtax thresholds) on investment income. Therefore, the "wealthy" earning more than $1MM per year, could see capital-gains go all the way to a staggering 43.4%! 

Medicare Surtax Thresholds

As this is in the "possible proposal stage" and isn't set in stone, there will undoubtedly be more information to come in the near future. However, those finding themselves under the "wealthy" definition may want to prepare for upcoming tax law changes that could effect their investment portfolios.

P.S....Biden also mentioned he is looking at changing the "step-up basis" that could be even more of a detrimental tax law change. More on that in the future.

STAY TUNED!


Sources

*www.briefing.com

*https://www.cnbc.com/2021/04/22/how-the-biden-capital-gains-tax-proposal-would-hit-the-wealthy.html

*https://legal1031.com/news/what-is-the-3-8-medicare-tax-or-net-investment-income-tax-niit/

**Past performance does not guarantee future results. -Indices are unmanaged and do not incur fees, one cannot directly invest in an index