Three Important Capital Gains Reforms in Finance  

Capital gains taxation is ripe for reform. Exempting de minimis cryptocurrency transactions from capital gains tax, indexing capital gains to inflation, and incentivizing investment in fixed income assets to enhance annuities for retirement are just a few examples of ways the framework for capital gains taxation can be improved and benefit the lives of millions of Americans. This article highlights three bills that ATR believes would improve the status quo for capital gains taxation.

Cryptocurrencies 

On July 25, 2024, Sen. Ted Budd (R-N.C.) introduced bipartisan legislation to shield small cryptocurrency transactions from capital gains taxation. Other cosponsors of the bill include Sens. Kyrsten Sinema (I-Ariz.), Cynthia Lummis (R-Wyo.), and Kirsten Gillibrand (D-N.Y.). 

The purpose of the Virtual Currency Tax Fairness Act is to allow Americans to use cryptocurrencies to purchase everyday goods or services without triggering a realization event that would require the imposition of capital gains tax. Cryptocurrencies used in trading or investing would still be subject to capital gains tax regardless of the size of the transaction. 

The bill specifically proposes a de minimis exemption for cryptocurrencies used in financial transactions—such as buying a cup of coffee or groceries. Proponents of cryptocurrencies emphasize that exemptions for capital gains would help facilitate the practical use of cryptocurrencies as a medium of exchange. This bill is not offering a tax loophole but is instead making it easier for cryptocurrencies to be used as a form of payment if the transaction is below $200. After calendar year 2025, the $200 threshold will be adjusted for inflation. The provisions in the bill will apply to transactions starting on January 1, 2025.  

A significant number of Americans already use cryptocurrencies to purchase goods and services. A Federal Reserve survey from May 2024 found that in 2023 over 2.5 million U.S. adults used a cryptocurrency “to buy something or make a payment.” The survey also found that adults “with income less than $25,000 were more likely than those with higher incomes to use cryptocurrency for financial transactions.” Lowering taxes on small cryptocurrency transactions would provide meaningful relief for lower income Americans. This tax change may also enable more Americans to use cryptocurrencies for everyday purchases.

Indexing Capital Gains to Inflation

A great complement to lowering the tax burden on cryptocurrencies would be legislation to index capital gains to inflation. Federal income tax brackets, the earned-income tax credit, and the standard deduction are already indexed to inflation, but not capital gains. Fortunately, Sen. Ted Cruz (R-Texas) has introduced legislation to index capital gains to inflation. Some Democrats have even supported the tax change. In 1992, Sen. Chuck Schumer (D-N.Y.), stated that: “If we really want to increase growth, there are proposals that we can do. I would be for indexing all capital gains and savings and borrowing.” Democrats should reach across the aisle once again and cosponsor Sen. Cruz’s legislation.

Indexing capital gains would better reflect taxes on real gains made on investments. Excessive government spending has resulted in a cumulative increase in inflation by more than 20 percent since President Biden was inaugurated. This has made it even more necessary to remove inflation from capital gains taxation. Americans should not have to pay taxes on ethereal gains that have nothing to do with the actual returns on their investments.

Indexing capital gains to inflation would benefit a large swath of Americans. Over 60 percent of U.S. adults are either directly invested in stock or exposed to it through an IRA or 401(k)—acknowledging that capital gains tax would not apply to gains made in a retirement account.

Imposing higher taxes on capital gains, such as the 44.6 percent tax endorsed by Democratic presidential candidate, Kamala Harris, would reduce returns for households with incomes far below $400,000. According to the Investment Company Institute, in 2023 the majority of mutual fund net assets were held in “tax-exempt funds” or “tax-advantaged accounts.” However, 33 percent of mutual fund total net assets were held in “taxable household accounts.” That number amounts to more than $8.4 trillion of mutual fund assets that are potentially subject to capital gains taxation. Indexing capital gains, not raising the tax rate,would reap dividends for households across the country.

According to Gallup, 63 percent of households earning between $40,000 and $99,999 are invested in stocks. About 29 percent of households earning less than $40,000 are invested in stocks. All these Americans households could see significant benefits by indexing capital gains to inflation. These Americans also aim to lose returns on their investments if Harris get her way.

Life Insurance  

Sen. Thom Tillis (R-N.C.) introduced a bipartisan bill to exempt certain bonds and other fixed income assets held by life insurance companies from the definition of a “capital asset.” This would exempt fixed income assets held by life insurance companies from capital gains taxation. However, ordinary income tax treatment applies to these fixed income assets. This tax change will provide life insurance companies with a lot more flexibility to manage their balance sheets.

One of the key benefits of the Secure Family Futures Act is its potential to encourage more investment in the fixed income market. Life insurance companies, which rely heavily on these assets to ensure they can meet their long-term liabilities, will now be better positioned to hold onto their investments without the burden of capital gains tax. This stability is crucial for the life insurance industry, which plays a vital role in the financial planning and security of millions of Americans.

This tax reform is especially beneficial for Americans buying annuities. Annuities provide retirees with a guaranteed stream of income. Ameliorating the tax treatment of life insurance investments will enhance returns or reduce costs for annuities offered by those same life insurance companies. Over the years annuities have become more popular. In fact, sales of “fixed-rate deferred annuities, have more than tripled in the last two years, rising to $164.9 billion in 2023 up from just over $50 billion in both 2020 and 2021.” More flexibility for the tax treatment of fixed income assets will pave the way for more affordable annuities for any Americans who want to purchase them. Sen. Tillis’s bill will enable more retirement options for all Americans.