Imagine you invested $100,000 in 2000. Today that amount has grown to $400,000. Under the current rules, the capital gain would be $300,000, and you’d pay 20 percent on that (if you were a high earner), or $60,000. Under the current proposal, however, your tax liability would drop to $50,000 because your original investment, accounting for inflation, was actually $150,000 and therefore your gain was $250,000. So you’d pay $10,000 less in taxes.
“It dramatically lowers tax liability for investors across the country,” said Ric Edelman, founder and executive chairman of Edelman Financial Services.
However, Edelman added, it would also make life a lot more complicated.
For example, mutual funds typically pay dividends quarterly, and so even if you reinvest that money, it’s considered a new investment by the IRS, Edelman said. That could mean that over 20 years, you might have to track the inflation of more than 80 different investment timelines, he said. “You could call it the ‘Tax Preparers Job Security Act,'” Edelman said, jokingly.
Should the change go into effect, investors who have been waiting to realize their capital gains will want to act quickly, said Hemel at The University of Chicago Law School. “If I were a private equity fund planning an exit from one of my investments, this is fantastic news,” he said.