How will Joe Biden’s capital gains tax rise affect crypto prices?

If you bought bitcoin or another cryptocurrency in the last few months, chances are your portfolio has seen both pain and joy in equal measure. We saw that yesterday when bitcoin tanked after Tesla’s Elon Musk said the company would no longer allow its cars to be bought with bitcoin.But crypto portfolios could face a much bigger threat in coming weeks: the capital gains taxes announced in US president Joe Biden’s $1.8trn “American Families Plan” last month.

What has he proposed and why does this spell trouble for crypto hodlers – even those who aren’t liable for the tax themselves?

Biden’s big capital gains tax hike

Biden wants to raise the highest long-term capital gains tax (CGT) rate in the US from 20% to 39.6% for people earning more than $1m a year. In the US, there are short-term (less than 12 months) and long-term (over a year) capital gains tax rates. Short-term gains are taxed at between 10% and 37%, while long-term gains attract a tax rate of 0%, 15% or 20%, depending on the individual’s income.

Bitcoin and several other cryptocurrencies have risen exponentially in the past year. As a result, longer-term holders now face the spectre of higher capital gains taxes –assuming that they keep holding. Those earning over $1m could end up paying 43.4% on any profits (that includes the existing 3.8% surcharge on higher income investors). And those in areas such as California or New York, with other taxes to add on top, could face handing over more than 50% of the profits on their crypto assets.

That’s quite the increase. And while Republicans strongly oppose Biden’s tax plans (which are partly to fund his two-stage infrastructure package, the “Build Back Better” plan), in reality he can push the package without bipartisan support if it turns out to be necessary. So there’s a decent chance of it actually getting onto the statute books.

The tax measures may trigger a sell-off in crypto markets

Clearly, if you’re going to see profits taxed more highly in the future, then some investors might like to take their profits now to be taxed at the lower rate. So it’s no surprise that news of the measures, proposed late last month, triggered a slide in the value of many crypto currencies.

And if the measures are pushed through, then the crypto market should brace itself for a sharp selloff, according to several tax experts MoneyWeek spoke to. “It’s a fair assumption that if the proposals become reality that it could generate some significant turbulence in the crypto markets as US investors seek to crystallise gains before any tax increase takes place,” says Chris Etherington, a private client tax partner at RSM UK.

Alex Straight, a partner at Blick Rothenberg, notes: “If Biden raises the long term capital gains tax rate to 39.6% for high earners who fall into that tax bracket, the benefit of holding onto your asset for greater than 12 months to achieve a tax saving would disappear. This tax difference is a key cost for regular people buying and selling cryptocurrency for ordinary use in the US.”

But he notes that as the tax benefit of holding for longer disappears as and when rates rise, more people could then trade more freely.

In the longer run however, the CGT measures will greatly alter the value of the crypto market, says Leigh Sayliss, partner at law firm Howard Kennedy: “Investors may wish to sell cryptocurrency, in order to crystallise any capital gain at the current tax rates – but that does not necessarily prevent other investors from wanting to buy the same currency once their gains have been locked in.”

Jason Cozens, founder and chief executive of fintech Glint says fears of higher inflation may still keep demand for cryptocurrencies strong irrespective of Biden’s plans: “Although the new CGT measures may be somewhat targeted at crypto holders, this could actually drive more consumers towards alternative currencies such as cryptos and gold as consumers are hit by increased taxation just as inflation spikes and interest rates remain at historic lows”.

So while investors should definitely have these tax rises on their radar, it isn’t a reason to completely freak out yet. Pay attention to the space but don’t put all your eggs in one bitcoin.