US long-term capital gains tax

[zbigi]

I just realised that, for a typical ERE (and likely even FIRE) scenario, Americans pay 0% capital gains tax, because they don't have any other income than stocks, and it's trivial to stay in the 0% tax bracket (the treshold is $48,350 for individuals and $96,700 for married couples).This is making investments into stock market immensely profitable, compared to situations in most other places in the world. Also, this is taking advantage of a sort of "loophole", where I imagine the legislators assumed that people who have considerable income from capital will also have high income from other places (work or SS and private pension), which will make income from investments fall into the 15% bracket. They didn't plan for a generation of slackers who will plan to live modestly off their investments, instead of giving their life to an endless cycle of work&spend. As the FIRE movement spreads, I imagine the "loophole" will be closed (tax authorities and politicians will eventually notice that they're leaving siginificant tax income on the table). In other words, if I were American planning my FIRE finances, I wouldn't assume I'd be paying 0% cap gains tax for the rest of my life.

[jacob]

We also enjoy 0% tax on dividends on the same bracket conditions.

On the other hand, US persons pay significantly more for education, health care, health insurance, senior care, legal services, ... than people in similarly developed countries despite not getting a better level of service. Lower taxes translate into "less government services", which you then have buy from the private sector (often mandatory and not always better), so it's basically a wash in terms of standard of living.

(Translation: non-US FIRE people don't need to save up as much given an equivalent level of frugality because much of what US FIRE people pay a lot for is free or very inexpensive elsewhere. For example, were we to move to Denmark, where I'd be taxed IIRC 27% on my dividends, our expenses would drop at least 30-40%.)

Many FIRE people "imagine" that politicians will come after their money if the idea spreads. There are two issues with that. First, it'll have to spread a lot more. Second and more importantly, it's difficult to write laws in a way that it doesn't affect those who complain the loudest more than it affects the FIRE people who are being complained about.

It is a good reminder [for the complainers] that (using typical US market ratios) each $250,000 invested creates $50,000/year in job salaries for employees along with the, say $5,000 that it pays out in tax free dividends.

Anyhoo.. perhaps more importantly, the tax-matrix of a given country explains a lot about people's preferred strategy. (This is also why it's dumb to copy US investment strategies if not living in the US or not living in a country with a similar tax-matrix.) For example, if stocks were taxed more, then housing might be taxed less ... and FIRE people would be talking about owning bricks and renting out homes instead of stocks. In other countries, people should perhaps be talking about bonds or annuities... This is actually quite evident inside the US because the states themselves have three levers to raise money: real estate taxes, sales taxes, and income taxes. In some states one or more of those are ZERO, but in those cases, the other one or two are almost always correspondingly higher to make up for the shortfall. This means that different financial behavior is encouraged/some behaviors pay more/but on average people pay about the same.

[7Wannabe5]

It is a good reminder [for the complainers] that (using typical US market ratios) each $250,000 invested creates $50,000/year in job salaries for employees along with the, say $5,000 that it pays out in tax free dividends.

How does the remaining $195,000 break down? It seems to me that many/most ERE folk could do better investing in their own small businesses or ventures.

[chenda]

I understand there's also a lot of fiscal transfers between different US states, wealthier states cross subsidising less wealthier states.

[jacob]

How does the remaining $195,000 break down? It seems to me that many/most ERE folk could do better investing in their own small businesses or ventures.

Very ballpark (for the average business but not weird ones like e.g. banks, youtube channels,...), figure that out of the revenue(*),
1/3 goes to buying the goods/material that are to sold
1/3 to salary
1/6 to maintenance, equipment, buildings, debt service, taxes, etc.
1/6 to be reinvested back into the company (or partly paid out in dividends)

(*) On the stockmarket, each $1 of annual revenue typically costs $1.5-2 in investments (the P/S ratio).

The main issue with "investing in your own small business" is that you just bought yourself a job which from a FIRE perspective was probably what you were trying to avoid in the first place. See e.g. those who go for real estate instead stocks and eventually find themselves working almost full time as a landlord/handyman.

[zbigi]

It is a good reminder [for the complainers] that (using typical US market ratios) each $250,000 invested creates $50,000/year in job salaries for employees along with the, say $5,000 that it pays out in tax free dividends.

This is of course an invitation to an eternal debate about effects of taxation - but - people who have $250k will not just stop investing that money because now they have to pay higher taxes. As long as taxes are below 100%, investing will bring them income, so it will make sense (it will be better than the alternative of not investing). Of course, some may resort to tax evasion or leave the country altogether if taxes get too high, which is what I see as highest downside from policymaker's perspective.

How does the remaining $195,000 break down? It seems to me that many/most ERE folk could do better investing in their own small businesses or ventures.

I don't think these numbers can be compared - investment is a one time payment, while the yearly $50k salary is an ongoing money flow.

[jacob]

This is of course an invitation to an eternal debate about effects of taxation - but - people who have $250k will not just stop investing that money because now they have to pay higher taxes. As long as taxes are below 100%, investing will bring them income, so it will make sense (it will be better than the alternative of not investing).

Not necessarily. Decisions are made at the margin. "Normal" people already prefer to spend their $100,000 on kitchen upgrade, restaurants, travel, fancy cars, drum sets,... over a $2,000/year increase in passive income. This is why savings rates in the general population are so low. I have never succeeded in convincing a muggle that insofar they invested their $3000 windfall/bonus/... they would get a free $150/year which could pay for xmas presents, etc. Nope, that money is very quickly flushed out the money hole. So, yes, people will definitely stop given how it's a wonder how some even got started.

Also note that as net incomes get lower, the 25x rule of thumb because a 35x or 45x ... which at some point exceeds expected lifespan at which point it's no longer worth it to bother investing for income at all as opposed to just buying something that keeps up with inflation (like a house).

[ducknald_don]

It seems to me that many/most ERE folk could do better investing in their own small businesses or ventures.

Personally I never wanted all my eggs in that one risky basket. Also small businesses are illiquid, they are difficult to sell. For me the business was an alternative to a traditional job and the investments were for when the business had run its course.

[7Wannabe5]

Very ballpark

Gotcha. That seems about right based on my small business, except working in the discard market you are generally going to make more effort to find product, but pay much less for it.

It is true that many don't want the hassle of own business even given possibility of hiring employees or otherwise outsourcing most of the work. OTOH, as can be seen with both immigrants and the elite class in the U.S., there can be huge benefits tax-wise and otherwise in creating a family business (or office or foundation, etc.) , and thereby creating jobs for your own dependents or close circle. Although, of course, the other problem with investing in your own business vs. creating a market portfolio is lack of diversification.

However, I remain rather fascinated with the definition of "capital" with meaning towards the line item of "equipment" or "tools." This also plays well with ERE because "tools" and "skills" obviously may correspond. So, for example, three independent skill-sets combined with investment in three corresponding tool-sets could create three relatively independent small businesses. If you are only trying to create an income flow of 1 Jacob =$7000/year, the tool-sets could be fairly unique and inexpensive and WOG coherent. I think the "unique" is somewhat important, because, for example, the typical digital nomad is only using the very commonplace "laptop, smartphone, and internet connection" tool-set, but if you just add a musical instrument, a fishing kit, and a metal detector (total investment estimate $3000) , you still might not even achieve $20/day (= approx.1 Jacob/365) in earnings and/or further savings on food/entertainment expenses, but you can likely afford to only make use of these tools/skills to the extent you find it enjoyable. IOW, since the $1000 you invested in a guitar would only bring return of $30/year, if "busking" is something you would willingly do to earn $5/hr wage for one hour/week, and your average revenue flow from busking is $7/hr., your yearly revenue flow would be $364, your wages paid to self would be $260, and that would leave $104 for your maybe $80 dividend and $24 for depreciation, guitar strings, etc. So, you will have already effectively freed yourself from Unpleasant Paid Work for Other for half/month per year with this very simple business. Applying a uniform 1 hr week/$1000 investment model with average $7/$5 hour revenue/wage, total investment would be around $24,000 and total ongoing enjoyable self-employed activities would average around 24 hours/week over 24 different activities/businesses. Obviously, all of these metrics could be personally tweaked except for expected hourly (and/or average/maximum over period) revenue per particular business activity/applied skill and tool-sets.

In the U.S. you will also have to pay self-employment income tax, but this will likely be a near wash with earned income credit at 1 Jacob income/expenses.

[Laura Ingalls]

@zbigi

And it can be more than $96k you quoted. There are a many other tax credits built into the system. EV credits, adoption credits, education credits.

We had dependent adult credit and the American Opportunity Credit to claim last year which yielded a $3k credit and almost $45k more of untaxed “headroom”. It did increase our state taxes by $1,600 and we gave DS $1k because the could have gotten $1k of the credit if he has used it.

[Sclass]

FIRE is kind of over in the US as far as I can see. I like to see it alive and well here but for them most part average people have moved on to dream another dream in America. People have given up on the possibility of living on $48,000 a year. I don’t think it’s going to spread to the extent that there will be new tax legislation to eliminate these “loopholes”. I don’t see a lot of mainstream stories about FIRE anymore.

I know it sounds nuts but the entirety of people 100 meters around me need $300k + to pay their bills. They’d balk at $48,000. When I turn on the news I see young couples saying they aren’t making it on $150,000/yr due to inflation. This is California. But I think it is that way at slightly less lofty levels in most metro areas in the US. Whether this is a hard reality or just a failing of the people is another discussion. Bottom line there aren’t going to be many people jumping up to live on $48,000 a year.

Sounds like a princely sum here but IRL people will laugh at you. Annual minimum wage is around $35,000 here.

My recollection was this tax reform was made during the Obama administration. They were trying to help low net worth retirees who owned some dividend stocks or long term investments. These folks don’t exactly have the tax target on their backs at the moment like the 1%ers who make the majority of their money through deferred long term capital gains which are untaxed without any limits. My feeling is the sentiment hasn’t changed much against the low net worth retirees drawing $25,000 of dividends a year to augment social security. They’re viewed as “the poor” and you’d be remiss taxing them. That’s why it’s capped at $48,000.

That being said it is great if you can live on a few Jacob’s or less. When I first EREd I managed to engineer my taxable income to pay 0% federal tax. Felt like a pretty cool life hack after paying 40% while working.

I run a small business. There are some hard limits on how much we can sell. The return is huge…I make a 20x markup on a bunch of cheap circuit boards and chips but there simply aren’t enough clients to scale my business up to the level of my investable capital. That would be nice to make 20x on all of my money every years. It just doesn’t work that way.

[loutfard]

Speculating on the evolution of US long-term capital gains tax exemptions is not very useful. You have close to zero leverage trying to influence that decision.

If you feel a future US capital gains tax is possible, and you want to stay subject to US taxation, you probably want to lower your need for financial capital and pad it with an extra safety margin.

[Scott 2]

Tax optimization is core financial strategy. It doesn't stop at capital gains. Smoothing the lifetime income curve is a massive optimization, especially coupled with low cashflow demands.

My effective tax rate on contacting last year was under twenty percent. The years without earnings, I pay essentially property tax and sales tax. Depending how you account for health insurance subsidies, my effective tax approaches 0.

Because skillful consumption drops you below the poverty threshold, threading that needle is more robust than it first seems. Remove those rules, and we're talking people in the street, seniors struggling to eat, etc.

The style of consumption is simply taxed less too. Groceries might have 1/3 the sales tax of eating in a restaurant. Nobody's tracking used items through the classifieds. A reason Facebook marketplace is favored over eBay.

My state doesn't tax retirement earnings. The plan is to make it up in sales and property taxes. Move to a smaller unincorporated space though, and even those property taxes shrink. Because it's not politically sustainably to tax the poor out of their homes.


The very wealthy are playing games too. Only with greater sums and higher efficacy. Call it a subsidy or loan, but it's still a tax break.

It's primarily the salaried earner paying astronomical percentages. I was stunned at the perks of contracting over salaried employment last year. The tax profile is way better.