The House Ways and Means Committee may release a draft of the $3.5 trillion social policy bill as early as next week, including the tax hikes needed to pay for it. That’s left wealthy taxpayers scrambling to do proactive planning, especially to avoid a possible doubling of the top capital gains tax rate to 39.6%, up from 20%, which could be retroactive to the date legislation is introduced.
For folks who need to raise cash or reposition assets, it may be prudent to sell those assets in the next few days, warns CPA Bob Keebler of Green Bay, Wisconsin in an alert to tax and financial professionals on Leimberg Services.
It’s not just a capital gains tax hike that’s at stake. There are more than half a dozen tax hikes that could be used as revenue raisers in the bill. The Democrats’ social policy goals are ambitious: paid family and medical leave, expanding Medicare to include dental, vision and hearing benefits, extending the enhanced child tax credit as well as provisions to address climate change.
Who would pay for all of this? The Democrats’ budget blueprint promises no new taxes on families making less than $400,000 per year, small business and family farms. It calls for “tax fairness for high-income individuals.”
“You’re going to see a tax increase no doubt,” says Pamela Lucina, head of the trust and advisory practice for Northern Trust. “Everything is sort of fair game.” A Northern Trust white paper, Navigating Possible Tax Policy Changes, hedges the likelihood of various tax hikes in play. It puts an increase in the top individual income tax rate and a small increase in the capital gains tax rate — to 25% or 30% — in the “most likely” category. “We’re acting as if all of these could be part of the final law as they negotiate and search for revenue,” she says.
So the thinking is that tax hikes are going to happen; it’s just a matter of which ones and when. “It’s like picking the NCAA bracket,” says Keebler. “You don’t know what the final deal’s going to look like when it’s carved at 3 in the morning.”
Here’s a laundry list at what could be coming.
Individual income tax hike. The top individual income tax rate could jump from 37% to 39.6% for those making more than $400,000 a year. Planning tips: Accelerate income. Consider Roth IRA conversions.
Higher capital gains tax rate. An Administration proposal would double the top tax rate from 20% to 39.6% on long-term capital gains and qualified dividends. Lucina says that Northern Trust predicts a smaller increase, with a new top rate of 25% or 30% more likely. She’s already been working through the calculus with clients to figure out whether they should or shouldn’t sell assets. “Taxes are a factor, but not the only factor,” she says. One client is selling a food distribution business, and rather than selling outright, he’s selling it on an installment basis which allows him to defer the capital gains. If the tax hike passes, and it’s not retroactive, he can opt out of the installment sale and take the gains all in 2021 under the lower rate. Planning tip: If you don’t need the money to fund short-term goals (1 to 10 years), perhaps you’re better holding off and not selling assets.
Deductions cap. Taxpayers could face a new cap on deductions including charitable contributions as well as IRA/401(k) contributions. Keebler has this one on his short list. So, for example, someone who pays taxes at the top 37% rate, would no longer get deductions applied at that full rate. Instead, the benefit of deductions would be capped at a 28% or 26% rate. Planning tip: Consider maxing out your retirement plan contributions and bunching charitable deductions into 2021.
Tax carried interest as ordinary income. Imagine an accountant, lawyer and the manager of a private equity fund all working on the same deal and at the end, the private equity guy pays half the tax rate on his income from the deal that the others pay because of the “carried interest” loophole. A proposed tax law change, which has bipartisan support, would level the playing field by taxing carried interest as ordinary income instead of as capital gains. Planning tip: Consider accelerating carried interest payouts.
Capital gains taxation at death or gift. Under current law, when you die, your appreciated assets get stepped up in value to their value at the date of your death. That means neither you nor your heirs ever pay capital gains tax on the unrealized appreciation of the asset before your death. The Administration has proposed making such unrealized capital gains taxable at death (or when an asset is transferred by gifting). There would still be a $1 million tax exemption for unrealized appreciation ($2 million for a married couple—plus the $500,000 per couple capital gain exemption for a primary residence). Planning tip: Incorporate flexibility into trust documents to allow for swapping of assets.
Return of the Gift & Estate Tax. The Trump tax cuts of 2017 temporarily doubled the estate tax exemption through 2025, leaving fewer than 2,000 estates a year that faced federal estate taxes. The exemption level is now $11.7 million per individual, set to revert to $5 million, indexed for inflation. What’s possible? A return of the base level exemption to $5 million, meaning a return of gift and estate taxes for many more families. Less likely—a return to $3.5 million (the 2009 level). Planning tip: Consider making lifetime gifts to heirs now.
Restricting GRATs and Valuation Discounts. There are many other estate planning techniques that the rich use to avoid taxes, and some of these could be in play. GRATs and valuation discounts let wealthy families transfer assets to their heirs virtually tax-free. Proposals under consideration include a 10-year minimum annuity term for GRATs, with a minimum gift amount to be contributed. Valuation discounts, used to pass down family businesses, could be curtailed, but this would get more pushback. Planning tip: Meet with your wealth advisor or estate planner to discuss wealth transfer techniques in 2021. These changes are less likely to be included in legislation as they could be made through regulations, which wouldn’t be retroactive.
Lift the SALT deduction cap. Finally, there’s one potential tax break for the rich in the mix! The budget blueprint calls for revamping the SALT deduction: relief from the current $10,000 cap on the state and local tax deduction. This would mean big savings on federal taxes, especially for folks in high-tax states.
Further Reading:
Betting On a Revamped SALT Tax Break? Skip September Estimated Payments To Save Big
Another State Ditches Its Estate Tax As Backdoor Federal Estate Tax Looms
Child Tax Credit Snafu Means August Payment Delay For Over 4 Million Taxpayers
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