The Future of Capital Gains Taxation

The Tax Management Transfer Pricing Report ™ provides news and analysis on U.S. and international governments’ tax policies regarding intercompany transfer pricing.

By Susan K. Duke, Esq.  

Duke Law Firm, P.C.,Lakeville, NY

The current capital gains tax rates are set to expire at the end of this year. Currently, capital gains tax rates are:

  •   0% for those in the 10% and 15% income tax brackets; and
  •   15% in all other tax brackets.

Unless new legislation is enacted by the end of 2012, taxpayers in the United States will see their capital gains income taxed at the following rates in 2013:

  •  The long-term capital gains tax rate will be 20% (10% for taxpayers in the 15% tax bracket); and
  •  The qualified five-year 18% capital gains rate (8% for taxpayers in the 15% tax bracket) will be reinstated.1

The capital gains tax rate breaks have already been extended a number of times. The rates were decreased, or decreases were extended, in 1990, 1997, 2001, 2003, 2005, and 2010. With the December 31, 2012 deadline rapidly approaching, Congress is again debating whether to keep some or all of the current capital gains tax rates in place through at least 2013.

Both Republicans and Democrats seem to desire some form of continued capital gains tax relief. However, the two parties generally disagree about whether wealthier taxpayers should benefit from decreased capital gains rates. The Republican Party seeks to extend all Bush-era tax cuts, while the Democrats wish to allow such cuts to expire for the wealthier households.

This summer, the Republican plan to extend all Bush tax cuts was defeated in the Democratic-led Senate by a vote of 54-45. The Senate then voted on the Democrat plan to allow tax rates to rise for those households earning more than $250,000, and the plan passed by a vote of 51-48.

While some Republicans suggested a filibuster in the Senate to prevent the Democrats' plan from passing, both parties seem aware of polls showing the general public's desire for wealthier taxpayers to pay a higher tax rate. Two Republicans voted for the Senate Democrats' plan, perhaps suggesting a fear of facing voters if they opposed such measures. However, many observers have pointed at the inherent risk of supporting legislation that increases any taxes, as that can be utilized during an election to infer the politician is in favor of increasing taxes in general.

After the Democrats' tax plan passed the Senate in July, the Republican-led House voted on August 1 to keep all Bush-era tax cuts in place. Apparently more concerned about voting to raise any taxes just prior to November elections, the House passed the Republican measure 256-171, with 19 Democrats voting with the Republicans. Only one Democrat voted with Republicans in the Senate on the same legislation.

While Senate Republicans threaten to filibuster the Democrat plan, President Obama threatens to veto the Republican plan. Problematic for the Republicans is their plan's estimated additional cost of $1 trillion over the next 10 years above the cost of the Democrats' plan, and the fact that the tax hike repeals proposed by the Democrats would only affect less than three percent of taxpayers. Obviously, this makes broad public support for the Republican plan difficult, as only a small percentage of taxpayers would benefit from the Republican measure.

Add to the public debate presidential-hopeful Mitt Romney's revelation that he paid an average of 14% of his income in taxes in recent years. Many have been shocked to learn that someone who earns more in a year than some earn in a lifetime pays such a small share of his income in taxes. The disclosure of Mr. Romney's tax information has led more voters to inquire what tax break leads to this inequity, and many find the answer, in large part, relates to reduced capital gains tax rates.

For the last two decades, the environment has been right for reduced capital gains tax rates. The initial impetus came from the decreasing federal deficit from 1990 until 2000, and President George W. Bush's general policy of cutting tax rates. However, with the recession and stimulus spending causing a massive increase in the deficit between 2008 and 2012, it is difficult for politicians to sell legislation that increases the deficit even further while giving the wealthiest households continued tax advantages.

Given the current political and economic environment, it seems unlikely that the low capital gains rates to which we have become accustomed will remain. Any legislation on taxes will likely not be finalized until after the November election. It seems likely that a partial extension of tax breaks, such as that proposed by the Democrats, will become law unless the Republicans manage to regain control of both the House and the Senate. If Republicans control both chambers of Congress, we can expect Congressional passage of an extension of all Bush-era tax rates, but President Obama, if re-elected, will almost certainly veto any such legislation. However, ultimately, both parties will likely agree that some reduction of taxes is better than none at all, and that any tax breaks benefiting the wealthiest of U.S. taxpayers are unlikely to gain favor with the majority of U.S. citizens.

For more information, in the Tax Management Portfolios, see Maule, 507 T.M., Income Tax Liability: Concepts and Calculation,  and in Tax Practice Series, see ¶3310, Computation of Tax - Individuals

 1 Beginning after Dec. 31, 2012, the capital gains income of upper income individuals also potentially will be subject to the 3.8% tax imposed by §1411 on net investment income. In addition to the scheduled increase in capital gains tax rates, under current law, dividends will be taxed in 2013 at taxpayers' ordinary income tax rates, regardless of their tax bracket.

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