Treasury Secretary Janet Yellen made waves over the weekend when she announced that the Biden administration is looking into taxing "unrealized" capital gainst in order to pay for the so-called "Build Back Better" plan.
NEW - U.S. Treasury Secretary Yellen proposes a tax on unrealized capital gains to finance Biden's "Build Back Better" plans.pic.twitter.com/pefi3PhoDe— Disclose.tv (@disclosetv) October 24, 2021
This is a big deal.
First off, the United States has a progessive tax system. That just means that as the tax rate increases, it is only applied to income above a certain threshold. Different kinds of income are taxed differently.
One of those types of income is "Capital Gains." All that means is that you invested in something that appreciated over time and turned a profit when you sold it. As the name implies, you are quite literally gaining from a past investment of capital.
The Democrats love to target this income stream because it is easy to sell their voters as a tax on the super wealthy. But you don't have to be heavily invested in the stock market to have Capital Gains. Middle class earners are often hit with Capital Gains taxes when they sell their homes for a significant profit.
The IRS treats short-term and long-term Capital Gains differently, but the point is that in order to be taxed on Capital Gains, the gain has to be realized. It has to be real.
When you hear Yellen and other Democrats talk about "unrealized" Capital Gains, they are talking about taxing you on the appreciation of your stocks or properties, even if you don't sell.
The Left claims this would only target the super-wealthy, but that is likely a lie. Every tax that began as a tax on the wealthy was eventually expanded to include the middle class.
So how would unrealized capital gains taxes work?
Let's say that you bought a single share of stock last year for $100. It was a really good investment because after a year, it has has doubled in value. If you wanted to sell a year later, you'd make $100 profit. But if sold it before the year was up, you'd have to pay short-term capital gains on the $100 profit. Basically, it gets treated as an additional $100 in income for that tax year.
This is one of the reasons that people try to avoid selling stocks for short term gains at the end of a tax year. Instead of selling and having to deal with the tax liabilities of their profit, people will often keep the stocks for even longer and wait for them to appreciate more before selling and taking the tax hit.
When Biden officials say they want to tax unrealized Capital Gains, that means they want to tax you on the appreciation whether or not you sell.
So, if that $100 stock doubles in value to $200, the government would tax the profits even if you didn't sell it.
When I explain this to people, the first thing they ask is, "what happens if the price drops after you're taxed on unrealized gains?" Well, we don't really have an answer.
Imagine that you're taxed on those unrealized gains for the single share of stock you bought. If you pay the taxes and immediately after, the stock price nose-dives back down to $100 a share, what happens then? Normally, people would be able to use realized losses to offset tax liabilities. Big losses can be carried over multiple years.
The system is deliberately designed not to count unrealized losses because it would be a recipe for fraud.
And what would happen if that now depreciated $100 stock had another rally and climbed back up to $200/share the next year? Would you have to pay unrealized capital gains on it a second time?
It is easy to see how this would have disastrous consequences in the market. If the government is going to tax investors whether they sell or not, then they might as well sell. At least then they get to enjoy the gains. The result would be massive selloffs in between Christmas and New Year's. Again: Why continue holding onto a volatile investment if the government is going to tax you as if you sold it?
Once this can of worms is opened, it will only get worse. Imagine getting audited and the auditor shows up with a property appraiser. He walks around your house and appraises it at $50,000 more than you paid for it a year ago.Congratulations, you now owe income tax on that unrealized $50,000 appreciation.
And if your house value crashes the following year, you'd just be SOL.
Margaret Thatcher famously said that the problem with socialism is eventually the socialists run out of other people's money. Well, we've reached that point with the Left so now they want to tax money you don't even have yet... And they're counting on you not paying attention so they can just rush this new tax through...