Most American think that the tax rate on capital gains for most taxpayers is 15 percent. But that is far from the whole story. For example, gains from the sale of collectibles, such as art or wine, are taxed at higher rates—though, for taxpayers subject to marginal rates of 28 percent or above, still less than wages or interest are taxed.

Then there are the gains on the sale of stock in a qualifying “small” business (with assets under $50 million). These profits are taxed at 14 percent—only a bit lower than the normal 15 percent rate. And even that advantage all but disappears for those small business owners hit by the Alternative Minimum Tax. For them, the effective capital gains rate is 14.98 percent.  

And getting to these “special rates” is no simple feat. When capital gains were taxed at the maximum rate of 28 percent, the “small business” lobby got half of these gains excluded from tax, making the effective rate 14 percent. But when the capital gains rate was reduced to 20 percent and, later, to 15 percent, the rule for small businesses remained unchanged, so they continued to pay 28 percent on half their gains, or 14 percent. To add to the complexity, small businesses operating in an “Empowerment Zone” get to exclude 60 percent of their gain, so their effective rate is only 11.2 percent.
 
You’d think that if Congress cared at all about tax simplicity, it would just get rid of these exemption rules and treat gains from the sale of these firms just like most other profits. If there are taxpayers in the 10 percent or 15 percent bracket realizing such gains, this change would actually be a tax cut! But Congress never passes up an opportunity to complexify.

So the new stimulus bill temporarily taxes just 25 percent of the gain from the sale of small business stock issued this year or next... Thus, the new effective rate is one-quarter of the ‘regular” rate-- or 7 percent for those in the 28 percent bracket or higher. (I calculate the minimum tax rate at 8.47 percent but the Committee says it is 12.88 percent-- don’t ask me why). That 7- percent rate is less than one-half of the typical 15 percent, a bit more generous than the ratio when all of this started back in 1991.

So why is it that Congress thinks it’s important to create an additional incentive for this particular investment over the next two years? It certainly does not seem worth all this complexity, including rates that vary with the issue date of the stock... Congress would do better to simplify the multiple rates applied to capital gains rather than adding a new one...