Driving home from work recently, I happened to be flipping radio channels and ran across the CSPAN XM channel and the discussion was “tax reform”. Having just finished our April 15 tax rush as a Firm, I was interested in this but then common sense kicked in – yea right. Tax reform? Given our dysfunctional Congress, powerful special interest groups – get real! A caller came on and made a pretty simple point. “Get rid of Capital Gains – all income should be taxed at the same tax rate”. Pretty simple and novel idea.
I read subsequently in the Kiplinger Tax Letter April 26, 2013 that investors should be aware of potential capital gains breaks ending in future years and that Senator Max Baucus will be pushing tax reform as his legacy now that he has decided to retire. Kiplinger mentioned the taxation of both capital gains and dividends as big-ticket breaks that might be eliminated in tax reform that could occur prior to 2015. The objective would be to obtain overall rate reduction – say a flat 28% rate at the cost of increased rates on capital gains and dividends. If Baucus pushes further that all income is taxed at the same rate – this would definitely simplify our tax code.
For small business owners and investors, a change to equate ordinary income with capital gains and dividend rates would make for significant short-term actions as well as changes in long-term planning. In the short-term, business owners and investors would need to measure whether harvesting existing long-term gains or sale of a business prior to the effective increase in capital gains rates makes sense. A lot of factors go into these determinations. In the long-term, investment decisions would be obviously affected by the effective increased tax rate on long-term gains and dividends. Structuring transactions would appear to become simpler if planning related to capital gain/ordinary income rate differences can be ignored. Decisions whether to invest would theoretically be adversely impacted by increased capital gain and dividend rates. However, it is unclear what a coupled overall rate reduction would have on economic activity.
Given Congress’ penchant for using favorable rates to encourage capital formation and economic activity, it may be a stretch that capital gains and dividends will be ultimately taxed at higher rates. The CSPAN caller’s idea may likely go the way of other recent flat-tax proposals; to the junk pile. Stay tuned to see if there develops a further push for overall rate reduction coupled with rate increases to capital gains and dividend taxation.
In the meantime, keep an eye on any momentum that develops for coupling the ordinary tax rate with capital gain and dividend rates. Be prepared to consider modifying your portfolio to harvest gains that make sense. Also, if you own a small business, make sure the financial statements are presentable to a potential buyer and get an idea of what it may be worth. You should be prepared in the case that you determine sale of the business is the right course of action, especially if a capital gains rate change comes as soon as 2015.