Preparing for a capital gains tax increase (US)

[theymos]

Context

In the US, President Biden is proposing to roughly double the top marginal long-term capital gains tax rate. The exact details have not been published, but at this point the rumors I'm hearing make it sound as though it would work like this: If you have capital gains (long-term plus short-term) higher than $1 million in a year, then each dollar over $1 million would be taxed at 43.4%. This is more similar to the Net Investment Income Tax rather than creating a new CG tax bracket; normally, your ordinary income basically shifts down the capital gains tax brackets for you so that more ordinary income causes you to pay higher CG tax rates, but from what I'm hearing, this will not be the case with this extra tax. The top marginal short-term capital gains tax rate would also increase from 40.8% to 43.4% on income above about $400k.

What actually gets passed into law may be different from what Biden proposed. All Republicans will vote against any tax increase, so each and every Democrat would have to agree to any tax increase. I watch politics very closely, and here's how I'd rate the chances:

• 30% probability: There is no LT capital gains tax increase at all. In the Senate, every Democrat up for reelection would prefer not to vote to increase taxes, since it will be used against them. Moderates like Manchin will be opposed to it because it hurts their moderate image. Even many deep-blue Democrats may be opposed to it in private because they represent places like Silicon Valley; I'd guess that the majority of unrealized capital gains are in deep blue states.
• 20% probability: Biden's proposal goes through basically intact. You may be surpised that I consider this so likely, since the moderate Democrats have a reputation for blocking big stuff like this, but the fact is that increasing taxes on people making more than $1 million is extremely popular, especially among the Democratic base, and if Biden and his allies choose to push hard on this particular issue, I'm pretty sure that they can get all Democrats, even Manchin, onboard. The question is whether Biden cares about this enough to grant the moderates a lot of concessions and spend a lot of political capital in order to force this through.
• 50% probability: Biden's proposal goes through, but with the rate reduced from 43.4% to 28-30%. This will help to appease the Democratic senators who would otherwise be opposed to it.

In any case, I expect the change to apply to sales made in 2022, not retroactively to sales made in 2021.

Spacing out gains

The proposed increase is only on capital gains above $1 million. If you have less than $1 million in unrealized gains, then maybe someday it will affect you, but probably no action is required now. If you have a few million dollars in unrealized gains, then you should consider whether you could spread these gains out over a few years to stay below the $1 million limit.

Spreading gains out is harder than it sounds. If you have $10 million in unrealized gains which you plan to spread out over 10 years to stay below the limit, you may run into problems like:

• Unexpected expenses may occur, such as unexpected medical bills. Or unanticipated expenses may be desired, such as deciding to move.
• The BTC price may go up, so now you're sitting on $100 million in unrealized gains. (A good problem to have in many ways, but a risk to consider.)
• The BTC price may go down, and this may cause you to lose faith in BTC and want to sell. If your $10 million in unrealized gains shrinks to $5 million because the BTC price got cut in half, are you going to be tempted to sell more, even at a higher tax rate? Relatedly, you might decide that other investments look more attractive than BTC, especially if you have a huge portion of your net worth in BTC. You won't be able to buy stocks with your BTC without realizing the capital gains, for example. Maybe now you don't think that this will ever be an issue, but trying to anticipate your mindset years in the future is very difficult.
• Tax laws may change. There was just a tax cut in 2017, for example.

Note that some services will give you a low-interest loan using your BTC (or other property) as collateral, similar to a home equity line of credit. This is a strategy commonly used by people like Jeff Bezos or Elon Musk who have most of their wealth in unrealized capital gains to avoid realizing the gains all at once. It's not a free lunch, though: you'll still be paying interest and fees.

You don't have to just sell all of your BTC and be rid of it forever. You can sell it to realize the gains, set aside the appropriate amount for taxes, and then immediately use the remaining dollars to buy back BTC. This is called tax gain harvesting, and it is a common tax strategy.

The value of waiting

For ease of calculation, in this section I will assume that the capital gains tax rate is increasing from 23.8% to 43.4% on all capital gains, not merely on amounts above $1 million, and ignoring tax brackets. Also, when I say that you are "realizing gains", I mean that you are doing tax gain harvesting: selling BTC and then immediately using the cash minus taxes to buy back BTC.

Let's say that you have some BTC with zero cost basis, now worth $1 million. So $1 million in unrealized capital gains. If you realize it now, you'll have $762,000 leftover. If you realize it this time next year and the BTC price is the same, you'll have only $566,000 leftover. Not great: you should've realized it this year.

However: If you realize your gains now and the BTC price quadruples, you'll have $3,048,000. Realize the remaining gains on that and you're left with $2,055,876. If the BTC price quadruples, and then you realize the gains, you'll have $2,264,000. It was better to wait to realize the gains in this example, though here we're assuming a pretty incredible quadrupling of the BTC price in 1 year.

If the BTC price ends up rising faster than the rate of inflation on average, then it may be worthwhile to wait to realize your gains. However, especially if the tax increase is as significant as Biden proposes, you might have to hold onto your BTC for decades in order to break even, depending on how much/quickly BTC rises. And if BTC rises slower than the rate of inflation, then all else being equal, it'd be better to realize your gains sooner. Nobody can predict with much accuracy where you, your mindset, Bitcoin, the tax system, the dollar, etc. will be in 10 years, so I caution against cavalierly making plans stretching decades into the future...

In the previous example where the BTC price quadruples, I'll say that the "holistic tax rate" is 1-(2055876/4000000) = 48.6% for the strategy of realizing gains now, and 1-(2264000/4000000) = 43.4% for the strategy of waiting until the BTC price rises 400%. This holistic tax rate takes into account both the actual taxes paid and the gains lost-out-on by selling sooner rather than later. Note that the holistic rate for the waiting strategy is the same as the 43.4% nominal tax rate.

I calculated the "realize now strategy" holistic tax rates for certain potential future tax rates and after-inflation BTC price increases:

Code:

                                      After-inflation BTC price rise
New tax|    100%     110%     150%     200%     400%     800%    1600%    2000%    4000%
       |--------------------------------------------------------------------------------------
23.80% | 23.800%  25.449%  29.845%  32.868%  37.402%  39.669%  40.802%  41.029%  41.482%
25.00% | 23.800%  25.532%  30.150%  33.325%  38.088%  40.469%  41.659%  41.898%  42.374%
28.00% | 23.800%  25.740%  30.912%  34.468%  39.802%  42.469%  43.803%  44.069%  44.603%
30.00% | 23.800%  25.878%  31.420%  35.230%  40.945%  43.803%  45.231%  45.517%  46.089%
35.00% | 23.800%  26.225%  32.690%  37.135%  43.803%  47.136%  48.803%  49.137%  49.803%
40.00% | 23.800%  26.571%  33.960%  39.040%  46.660%  50.470%  52.375%  52.756%  53.518%
43.40% | 23.800%  26.806%  34.824%  40.335%  48.603%  52.737%  54.804%  55.217%  56.044%

H=1-(0.762-T*0.762+(T*0.762)/G)

Ignoring tax brackets/limits and ignoring/assuming many things about the future, your circumstances, etc.: It'd make more sense to realize gains now rather than wait if the holistic tax rate in the table above is lower than the nominal tax rate on the left. For example, it'd be better to realize gains now if you think that the tax rate will rise to 43.4% and you think that BTC will increase by 150% by the time you want to sell, because 34.8% is less than 43.4%. But it'd be better to wait if you think that the tax rate will rise to 30% and you think that BTC will increase by 400% by the time you want to sell, because 40.9% is greater than 30%.

Use the table/formula above only as a very rough guide. I totally ignored brackets, limits, cost bases, etc. in the above calculations, but these are very significant and should definitely be accounted for. You should do your own calculations taking these into account, as well as your personal circumstances. You may have state capital gains taxes, for example, and some states are even considering increasing these on top of the possible federal increase.

Also, importantly, the BTC price increases above are after inflation. If BTC increases to $1 million in 10 years, then that's a 2000% increase from $50k pre-inflation, but a 1562% increase after inflation if inflation averages 2.5%/yr over those 10 years.

I am not a tax professional or financial planner. This is not tax or legal advice.

[1714971990]

1714971990

[1714971990]

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[1714971990]

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[1714971990]

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[paxmao]

Oh my! Theymos is on the bear side! He is selling! And he says bitcoin will likely not quadruple in price this year!

...

You don't have to just sell all of your BTC and be rid of it forever...

Thank gods!

I think that the main point here is spacing and it has a lot to do with how much bitcoin you got and with your lifestyle. The scenarios would need to be adapted to each country and each individual capital tax gains, so it is useful even if the political context would be other. For me the key question is Are you going to be exchanging more than 400k or a million a year (if in US) to fiat? Most people will be already out of the hook looking at that one.

I am not so sure you can buy stocks without going through fiat. Happy to know if someone knows how as of today. OTC maybe... probably not even in that case. You can also go and live 5 years on a tax haven, become a resident and... pay almost nil - yep, not an option to everyone.

[disconnectme]

I don't se this tax gain getting passed in the Senate, to me it is just to make noise because of the campaign promises he made during election campaign. I read somewhere that some of these Billionaires are getting divorced because of this coming Capital gain tax to protect themselves, rich people are not stupid and if it happens to pass, they will find a loop hole around it

[ReiMomo]

I don't se this tax gain getting passed in the Senate, to me it is just to make noise because of the campaign promises he made during election campaign. I read somewhere that some of these Billionaires are getting divorced because of this coming Capital gain tax to protect themselves, rich people are not stupid and if it happens to pass, they will find a loop hole around it

Guess what, no financial advisor would give and advise and tell people that they should spend all the gains they had. And the majority of them would say to reinvest it so it won’t be taxable.

Taxation really is complex stuff. People could take advantage of it and break them, as well. And for that, I would suggest that people have to hire a great accountant to do the job. You can always have less tax without doing anything illegal. An accountant will handle it for you as there is a lot of tax options to help you ease it.

[Sithara007]

Everyone expects the Bitcoin prices to go up for ever, so when the correction occurs (similar to what happened in 2014-15 and 2018), most of the users are not prepared. Given the fact that Bitcoin prices have gone up by 400% during the last 12 months, there is some possibility of a correction occurring in the next few months.

As Theymos pointed out, the tax increases can't be implemented retroactively. So for sales being made up to March 31, 2022 the new taxes are not applicable. If you were having plans to sell some of your coins in the next 2-3 years, then it won't be a bad idea to do it before the date that I mentioned earlier. Two reasons - 1. taxes are going to increase from 1st April 2022 and 2. Republicans are unlikely to win the 2024 elections.

Also, there is a proposal from the Democrats to tax unrealized capital gains. This is where it gets really scary.

[paxmao]

Taxing unrealised capital gains would be a really bad idea. There is a good reason why these are called "unrealised" right? It could come to the case that you would be forced to sell shares or asset to pay taxes because they have gone up. That would really be a shock to the financial world... people selling all at the same time at a certain point in the year, people not being able to properly keep a long term portfolio since they have to sell frequently, ...

I do not see that coming, it would mess up too much the 401k and other vehicles and create a serious issue for the financial industry.

[mu_enrico]

2. Republicans are unlikely to win the 2024 elections.

With the weak leadership from Sleepy Joe: border crisis, energy crisis, middle east crisis -> people will look for 2024 MAGA
That said, maybe Trump will revise this tax policy, so you guys can cash out in 2024.

Not a financial advice obviously

[icopress]

Correct me if I am wrong, but accepting any of the options will suspend a long-standing provision in the US tax code, according to which, according to which, the tax on income on investments should be lower than on wages. In addition, the Biden administration's claims that the tax code update will ultimately bring trillions of dollars into the budget ... are wrong, (in the sense that in reality it will only increase the public debt). I immediately recall one well-known saying "everyone enjoys the rights in the constitution, but few people want to be responsible for paying taxes." One way or another, I still do not understand how a person who has worked in public service all his life can talk about social inequality ... (after all, the essence of these tax changes is precisely in this).

[paxmao]

2. Republicans are unlikely to win the 2024 elections.

With the weak leadership from Sleepy Joe: border crisis, energy crisis, middle east crisis -> people will look for 2024 MAGA
That said, maybe Trump will revise this tax policy, so you guys can cash out in 2024.

Not a financial advice obviously

You know perfectly well that he will never stand a chance without his twitter account, that is, if he manages to stay out of prison and out of debt. The hold he has on the RP will weaken during these four years if Joe is able to do something half-good with the economy which seems quite likely. I think he stands the chance of doing so and trumpism only works if there is fear of the supporting masses.

Edited to add:
Just to be clear, I do not support any particular party in the US, I just like politics to make some sense and be as boring as possible - and the more predictable the better.

[Emitdama]

It is very very rare to see theymos in these parts of the forum, to start even a topic, to discuss something about USA, that is really a big deal if you ask me.

I believe the biggest chance would be the drop of course but you think Biden didn't consider that? That is the trick with the situation Biden is in and they are very aware of that. They give a huge number, a number they know will not happen, and then drop it to numbers they know will accepted and then everyone acts like "Biden wanted 43%!!! we dropped it to 30%!!!" whereas the current version is 23%, so it still gets higher, but everyone wins, Biden gets to hike the tax, republicans and manchin likes get to brag about how they dropped it a lot. That is the case here and that is the case in almost everything right now.

With the vaccination being free on healthcare is another topic for example where I think free healthcare will start, vaccination is free, maybe one more thing will get free, and then who knows, one day everything could be free. Step by step man, it is awesome.

[paxmao]

...
With the vaccination being free on healthcare is another topic for example where I think free healthcare will start, vaccination is free, maybe one more thing will get free, and then who knows, one day everything could be free. Step by step man, it is awesome.

As the economy progresses more things become free or at least widely affordable. My thinking about the future is that, if we do things right, we may as humanity reach a point in which our basic needs, even some of the advanced needs, will be covered by bot and AI workings. If that happens, many political ideas will become simply obsolete.

The only supporting evidence that I can offer for it is the fact that a few hundred years ago anyone who could live 70 or more years, did not have to suffer extreme pain, did not have to work hard (meaning long hours of really hard physical work) for their basic needs and had access to quite decent medicine would already be considered extremely prosperous, if not a king.

On the topic, of course Biden will have to negotiate, but that is already something quite different to what was happening in US before right? An he is not tweeting shit about all the guys that happen to disagree with him.  Just how I like it, boring, predictable, ... the older the better even at the cost of an occasional doze-off or a "where was I... yes... hold on...".

[Meistro]

They should not be increasing the capital gains tax, taxes are already too high as it is.

[El duderino_]

Thx for some insights in the US system....

In our areas EU, it works differently... as different for each country....

If taxes becoming crazy, you still can consider some different areas etc

[Kakmakr]

A question :

How can you pay capital gains taxes on something where you have not received any gains? Should Capital gains not only have an affect when you sell some coins and you receive the fiat value? (minus the purchase price)

Let's say for example I have 100 bitcoins and I keep that in a wallet. I only bought those coins and hoarded it, so I cannot pay taxes on something that did not generate any income for me.

I ask this question, because some governments want people to pay taxes on the bitcoins they own and not on the actual gain that they will receive when they sell those coins in the future. (They might even sell those coins at a loss in a few years, so then there will not be any profits or gain from those coins) 

[theymos]

As the economy progresses more things become free or at least widely affordable. My thinking about the future is that, if we do things right, we may as humanity reach a point in which our basic needs, even some of the advanced needs, will be covered by bot and AI workings.

We may someday... But it's a common problem for people to incorrectly act as though we live in a post-scarcity world right now, and thereby make disastrous plans. Even the Soviet Union often had this mindset, even though in hindisight we were much farther from post-scarcity in the time of the Soviet Union.

Our economy may be efficient enough nowadays that it might be able to survive giving everyone $xxxx/month, for example, though that would definitely reduce economic growth. And if this "free money" grows beyond the point where the economy can bear it, you'd see price inflation and shortages.

How can you pay capital gains taxes on something where you have not received any gains?

In the US, you don't have capital gains if the coins are just sitting around. But if you trade BTC for some other coin, or somehow trade BTC for stocks, or buy goods with BTC, then these are all taxable transactions, even if there was no fiat currency: you've earned capital gains equal to the fair market value of the non-BTC side of the trade. (This is not tax advice. Talk to a tax professional.)

A tax on unrealized gains and/or total wealth (which have been proposed in the US but aren't likely IMO) would be difficult, and would force you to sell. BTC is actually comparatively easy here, since many people have unrealized capital gains on things that they can't easily sell, like restricted shares, land, ownership in a private business, etc.

They should not be increasing the capital gains tax, taxes are already too high as it is.

If I was emperor, I'd abolish government entirely (or as close as possible)... But if I was instead required to design an income tax system which would collect a specific amount of money each year, I think that I would make the capital gains rate the same as the earned income rate. I'd also eliminate step-up-basis with the estate tax, if I couldn't eliminate the estate tax entirely. Both of these things just seem unfair to me, and they distort the market. Why should people be incentivized to sit on assets for a year? How does it make any sense for bond interest to be taxed more than stock dividends? Why should stock researchers who spend 8 hours per day picking the right stocks pay less in tax than welders? However, I would also make these three substantial tax-lowering changes:

• Every year, you should be able to optionally report that your net worth (assets minus liabilities) was at least $X, and then you should get a credit depending on the inflation that year. For example, if the inflation rate was 2%, then you should be able to reduce your investment income (interest, dividends, and capital gains/losses) by 2% of $X. Inflation is basically a tax, and not having this credit discourages people from investing in safer investments; you need to at least beat inflation, and any gains are reduced by taxes, so you need at least ~4%/yr gain to just break even, which requires taking substantial risk.
• If you receive any dividends from a company that pays taxes, you should get a credit for your share of those taxes. For example, if you receive a $1/share dividend from AAPL, and AAPL paid $0.05/share in taxes, then only $0.95/share of your dividend should be taxable. Otherwise you're taxed twice: once at the corporate-tax level and once at the dividend tax level. Alternatively, just get rid of the corporate tax.
• Capital losses should carry forward with unlimited time and amount.

Correct me if I am wrong, but accepting any of the options will suspend a long-standing provision in the US tax code, according to which, according to which, the tax on income on investments should be lower than on wages.

There have been periods of time where there was no favorable tax treatment for capital gains. It's never been nearly as high as 43.4%, but that's because the top marginal tax rate was much lower at the times when all income had the same tax rate.

In addition, the Biden administration's claims that the tax code update will ultimately bring trillions of dollars into the budget ... are wrong

True, in large part because people will use strategies like those I talked about in this topic.

As Theymos pointed out, the tax increases can't be implemented retroactively. So for sales being made up to March 31, 2022 the new taxes are not applicable. If you were having plans to sell some of your coins in the next 2-3 years, then it won't be a bad idea to do it before the date that I mentioned earlier.

They legally probably can be implemented retroactively, but I don't think they will be. It will probably take effect on sales starting Jan 1, 2022.

[PrimeNumber7]

Spacing out gains

The proposed increase is only on capital gains above $1 million. If you have less than $1 million in unrealized gains, then maybe someday it will affect you, but probably no action is required now. If you have a few million dollars in unrealized gains, then you should consider whether you could spread these gains out over a few years to stay below the $1 million limit.

Spreading gains out is harder than it sounds. If you have $10 million in unrealized gains which you plan to spread out over 10 years to stay below the limit, you may run into problems like:

• Unexpected expenses may occur, such as unexpected medical bills. Or unanticipated expenses may be desired, such as deciding to move.
• The BTC price may go up, so now you're sitting on $100 million in unrealized gains. (A good problem to have in many ways, but a risk to consider.)
• The BTC price may go down, and this may cause you to lose faith in BTC and want to sell. If your $10 million in unrealized gains shrinks to $5 million because the BTC price got cut in half, are you going to be tempted to sell more, even at a higher tax rate? Relatedly, you might decide that other investments look more attractive than BTC, especially if you have a huge portion of your net worth in BTC. You won't be able to buy stocks with your BTC without realizing the capital gains, for example. Maybe now you don't think that this will ever be an issue, but trying to anticipate your mindset years in the future is very difficult.
• Tax laws may change. There was just a tax cut in 2017, for example.

The price of bitcoin going up is not a problem, as it would mean that you have additional unexpected gains, and are better off tomorrow than you would have been today if you sold everything (or you were better off than you had planned).

The biggest risk to spreading out gains over time is that you cannot hedge your gains without risking having to pay taxes immediately. So spreading out gains over years means you must take price risk over the number of years you are spreading your gains over. In your example of selling $1 million worth of bitcoin over 10 years, if when you sell in year 2, the price declines by 50% (not uncommon to have this large of price declines), you will have lost $1 million, less your tax savings. Assuming that capital gains taxes increase by 20%, and only apply to capital gains over $1 million (the first million in capital gains are subject to the old rules), if you had sold $2 million instead of $1 million, and did not sell in year two, you would have an additional tax liability of $200k, and a net gain of $800k.

 

Note that some services will give you a low-interest loan using your BTC (or other property) as collateral, similar to a home equity line of credit. This is a strategy commonly used by people like Jeff Bezos or Elon Musk who have most of their wealth in unrealized capital gains to avoid realizing the gains all at once. It's not a free lunch, though: you'll still be paying interest and fees.

This strategy is risky for someone borrowing against a volatile asset such as bitcoin. If you borrow too much against your coin, the lender may force a sale of your collateral, triggering a large capital gains tax bill in a single year. For example, if you borrow 50% of the value of your coin, and in a year, the price of bitcoin declines by 40%, the lender may liquidate all of your coin in order to satisfy your loan, and you would need to pay taxes on any gains that you just realized. 

You don't have to just sell all of your BTC and be rid of it forever. You can sell it to realize the gains, set aside the appropriate amount for taxes, and then immediately use the remaining dollars to buy back BTC. This is called tax gain harvesting, and it is a common tax strategy.

IMO, this is superior to most alternatives, and probably makes sense under most realistic scenarios in which capital gains taxes increases substantially. This might be modified so that not all of residual assets are used to repurchase bitcoin so some money can be used for living expenses.

The value of waiting

It is never a guarantee any asset will continue to rise. This is not to say that it will not. IMO a bigger risk to medium-term prices is interest rates and inflation. If inflation rises over the medium term, the fed will need to stop QE, which will remove the amount of money in the market being used for speculation. Interst rates rising will mean the NPV of investments will decline, all else being equal.

[Silberman]

It seems politicians cannot see farther ahead than their own noses, a law like that will create an incentive to hold your assets forever, everyone but especially the powerful will make an effort to not pay as much in taxes, something which is natural especially when the level of taxation is so outrageous, the proposal is so out there that in fact I am wondering if this is not a case of Biden playing 3D Chess and wanting exactly this, is this an attempt to try to push the stock market up by reducing the supply of stocks on the market as no one wants to sell while at the same time they increase the demand by printing more money?

[dkbit98]

If I was emperor, I'd abolish government entirely (or as close as possible)...

You would abolish government and stay in place as dictator emperor like Caesar?

I think that modern government model is more corrupt than ever and it is doing more harm than good, but I wonder what would all the brainwashed people do without government and/or without emperor.
Many would probably die especially if they worked as government employees but ones who survive may build some new system that actually works better (at least for some time).

[paxmao]

...

...

Our economy may be efficient enough nowadays that it might be able to survive giving everyone $xxxx/month, for example, though that would definitely reduce economic growth. And if this "free money" grows beyond the point where the economy can bear it, you'd see price inflation and shortages.

I guess the first test will be paying the bill of the X$ a month given to people during COVID. And let us have no doubt, this bill has not been paid yet and will not appear evident until the money starts circulating full speed and creating the inflation that CB just cannot afford given the debt of most countries. Who wants to bet on when and how intense the bill shall be and how will affect the average joe with a mortgage larger than life?

[jaysabi]

2. Republicans are unlikely to win the 2024 elections.

With the weak leadership from Sleepy Joe: border crisis, energy crisis, middle east crisis -> people will look for 2024 MAGA
That said, maybe Trump will revise this tax policy, so you guys can cash out in 2024.

Not a financial advice obviously

I think he stands the chance of doing so and trumpism only works if there is fear of the supporting masses.

Republicans are motivated almost exclusively by fear, so there's no shortage of things Trump our any other demagogue would be able to exploit and rally the feeble-minded around.  The thing that drives republicans now is their fear that they're being replaced in the economy and losing economic and political power, which is why they fight so hard to undermine democracy now.  When they say "make America great again" they're necessarily invoking a time when white people had more political power.  They're so threatened by actual democracy they'll storm the the capital in an attempt to stop it.