A New Era of Higher Taxes

Yesterday, President Joe Biden unveiled a new plan to increase capital gains taxes. A capital gains tax is a tax on the gains earned when you sell an investment. For example, if you buy a mutual fund for $1,000 and sell it for $2,000, you would earn a capital gain of $1,000. ๐Ÿ’ฐ
The President proposed that the capital gains tax rate be increased from 20% to 43.4% for U.S. citizens earning at least $1 million per year. While most of us don’t earn $1 million per year, this tax increase is a harbinger for the future. When the federal income tax was first introduced in 1913, it was advertised as a tax on the wealthy. Only the wealthy paid it, to the tune of 1% on their income over $3,000 per year (that would be $80,000 today). ๐Ÿ’ฒ๐Ÿ’ฒ
However, we’ve seen how the income tax has progressed. Today, most income taxes are paid by the middle class, not the wealthy. In fact, the wealthy sometimes pay much less in tax since they are able to take advantage of tax shelters and expensive CPAs who can help them avoid taxes legally.
Most of the middle class pay 15% on capital gains, plus state and local taxes which can increase that bill another 5-10%. However, being prepared for higher taxes is a good idea, even if those taxes aren’t immediately forthcoming. Even if you don’t earn $1 million per year, there are still many ways you can legally avoid capital gains taxes. In addition to maximizing contributions to a Health Savings Account (HSA), Individual Retirement Arrangement (IRA), 401(K), or Thrift Savings Plan (TSP), here are four strategies you can use to take advantage of tax incentives.
1. Establish a Trust. ๐Ÿ’ช
A trust is a relationship where property is held by one party for the benefit of another. There are trusts that can shield your investments from capital gains taxes. One example is a capital gains bypass trust. However, you should research each type of trust thoroughly and consult with a tax professional to see if it’s a good fit for you.
2. Wait to sell your investments. ๐Ÿ‘
Under current tax law, if you make less than a certain amount of earned income, you can avoid federal capital gains taxes. With this strategy you might wait to sell your investments if you plan to decrease your earned income at some point in the future. This might be a financial freedom plan where you don’t have to work as much because you have higher passive income.
3. Don’t sell your investments. ๐Ÿ‘จโ€๐Ÿ‘ฉโ€๐Ÿ‘งโ€๐Ÿ‘ฆ
Legend Jack Bogle once said the key to investing success was to buy everything and hold it forever. While this may not necessarily be you, if you plan to leave assets to your children, this is an option. You don’t have to pay a capital gain until you sell an investment. Hence, if you hang onto all of your mutual funds and exchange traded funds (ETF) that you want to leave to your children, when you pass away the assets will transition to them capital gains tax-free (they may still have to pay inheritance taxes, but that is a separate issue).
4. Move To Another State. ๐Ÿšš
In this new normal of work-from-home, it has become much easier to move to a state with lower taxes. Many residents of high tax states like New York and California have moved to lower tax states like Florida and Texas in order to take advantage of the new economy. Another option is to move to Puerto Rico, where you’ll also be exempt from Federal income taxes and capital gains taxes. If you are okay not having the ability to vote (since Puerto Rico is a territory and not a state) and you are interested in island living, it might be the place for you. ๐Ÿ–๐Ÿ
Have a great weekend, and I’ll talk to you again soon!

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