Biden’s Capital Gains Proposal: Unfair To Lifetime Entrepreneurs?

Biden’s new capital gains proposal aims to tax the rich, but really, it may unfairly penalize lifelong entrepreneurs and ordinary investors cashing in on their success. The White House recently released a fact sheet describing its tax proposals for the fiscal year 2025 budget. Included among these proposals is a provision which would tax long-term capital gains as ordinary income for households making over $1 million a year.

Currently the maximum federal income tax rate on long-term capital gains is 23.8 %. The president’s proposal would increase the highest tax rate on long-term capital gains to 44.6%. There are many good reasons to tax long-term capital gains at a lower rate than ordinary income, however that discussion is beyond the scope of this article.

There are situations in which there is a glaring lack of fairness in this proposal that could be easily fixed. Consider the following taxpayers:

1. Ms. A has owned a business for forty years which has been her life’s work. She has taken small salary so that profits of the business can be reinvested to grow the business. In 2026 she sells the business for several million dollars, all of which is capital gain

2. Mr. B has owned shares in a publicly traded company that he has worked for many years. Even though his salary is small, the stock has done extremely well, and he is fortunate enough to have stock worth several million dollars. The company is sold for cash in 2026.

3. Mr. and Ms. C were fortunate enough to have bought a home in a fast-growing area 50 years ago. The home represents 90% of their net worth. They decide to downsize in 2026 and sell their house for several million dollars.

It is possible that none of these taxpayers have ever had a year in which their income exceeded $100,000 prior to the sale. But in the year of sale their household income will be more than $1,000,000 and their capital gain would be taxed at 44.6% under the President’s proposal. One easy solution to this problem would be to exclude the long-term capital gains from the $1 million dollar income threshold. Thus only those taxpayers who have more than $1 million of ordinary income, without regard to capital gains would be subject to the higher rate on capital gains.

This simple solution may not be acceptable to the White House since it would not reach taxpayers with great wealth whose only source of income is long-term capital gains. Another approach to incorporate the genuinely affluent taxpayer into this broader base would be to base the $1 million threshold on the highest income from the three previous years. Thus only those taxpayers whose income exceeded $1 million in any of the prior three years would have their capital gains taxed as ordinary income.

By considering adjustments to the income threshold, the Biden proposal can achieve its goal without unfairly including those who have modest annual incomes but experience one-time windfalls.

This article can be seen on Forbes.com.  

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