LEVATUS Q & A | 5 Questions on Potential 2021 Tax Changes with Liz Darling
Liz Darling, LEVATUS Senior Client Advisor, answers questions about potential 2021 tax changes and how they might impact wealth planning and strategy.
Photo by JD Designs
Starting with the 2020 Presidential race and continuing into the summer of 2021, proposed tax changes, namely increases to income and capital gains taxes, have been on many investors’ minds. Although there is slightly more clarity now than there was last November, there are still quite a few uncertainties. Jessica Grande asked Liz Darling, LEVATUS Senior Client Advisor, some of the most pressing questions on client’s minds..
We have been hearing about potential tax changes for quite some time, is there a specific reason for these changes?
The Biden administration has proposed tax increases, both on corporations and high-income earners, to fund legislative priorities including the American Jobs Plan and the American Families Plan. The tax proposals aim to generate an additional $3.6 trillion of federal tax receipts between 2022 and 2031 which translates into $2.4 trillion of net receipts, after taking into account new and expanded tax credits and other incentives.
The American Jobs Plan is designed with the objective of transforming and renewing infrastructure in the United States. The goal of this legislation is to support housing & infrastructure revitalization and prioritize clean energy, among other things. Corporate tax reform is integrated within the plan as a funding mechanism.
The American Families Plan targets helping families cover basic expenses, lowering health insurance premiums, and extending elements of the COVID American Rescue Plan that are directed at reducing child poverty. The plan targets improving tax administration and compliance, closing loopholes, and strengthening taxation on high-income taxpayers as funding mechanisms.
There seem to be some recent developments. What do we know now?
On May 28, 2021, the Biden administration released its fiscal year 2022 budget proposal, which includes more specifics around the funding of the American Jobs Plan and the American Families Plan. The Treasury Department has also released its highly anticipated “Green Book,” which provides additional detail around the administration’s tax proposals.
Proposed changes on income tax rates include an increase in the top marginal income rate to 39.6%, up from the current 37%. That rate would affect single individuals with taxable income of more than $452,700 and married couples filing jointly with income over $509,300. This increase is in line with the rates that will come back into place if the ‘Tax Cuts and Jobs Act’ tax reductions are allowed to sunset in 2025, which is likely given the composition of Congress.
The President’s plan for capital gains tax rates was also included in the recent releases, with proposals for an increase in the long-term capital gains tax rate, as well as qualified dividends. The proposed increase to 39.6% would almost double the current rate (20%) for people with taxable income of $1 million or greater. When combined with the Net Investment Income Tax, the proposed tax would result in a total tax rate of 43.4% on long-term capital gains and qualified dividends for those earning more than $1 million per year. The proposal also eliminates step-up basis for capital gains taxation.
The Treasury Department’s detailed explanations of President Biden’s $6 trillion budget confirmed the administration is seeking a retroactive effective date of April 28, 2021, on a capital-gains tax rate hike. According to Treasury officials, the purpose of backdating the effective date is to avoid a sell-off window ahead of a known tax rate hike cutoff date.
When might these proposals become law and be implemented?
It is unclear how much of the plan being proposed by the Biden administration will become law. A lot will depend on whether a bi-partisan solution is sought and achieved, and how much time the Democratic leadership in Congress is willing to devote to negotiations. If negotiations fail there is a chance that Congress will move forward with a process called Reconciliation which requires a slimmer margin in favor and therefor takes less time. If Congress gives a green light to one or more reconciliation bills, things can move quite quickly, with passage in a matter of months.
We originally expected proposed legislation to be passed or denied around the fiscal year end of September 30, 2021 but now it seems the timetable could be pushed forward to this summer. All of the proposed changes are slated to affect income taxes for the year ending December 31, 2021.
What is LEVATUS doing to prepare my portfolio?
The tax piece of the proposed legislation is wide ranging and will likely impact many clients if implemented in its entirety. At this stage, planning and scenario analysis, not action, is appropriate. Every client situation has its own nuances, but some broad areas of analysis we are focusing on now include:
Concentrated positions with large, embedded capital gains; especially if client Adjusted Gross Income (AGI) is low.
Legacy assets where a step up in basis was part of an overall estate planning strategy; stepped up cost basis may be eliminated under the new plan
Benefit of sheltering additional assets now via a ROTH conversion at a known tax rate.
Philanthropic planning to offset any large capital gains that may push AGI above thresholds outlined in current proposals.
What should I be doing to prepare myself?
It can feel challenging to make a plan with so many unknowns still on the horizon, however, it is a good time think through some ways you may be able to offset the increase in taxes should they occur. Focusing on areas where you have control is a great place to begin.
Here are some ideas:
Clarify your understanding of how close you are to the proposed thresholds.
o Am I close to the $1mm AGI?
o What do I expect my taxable income to be this year?
o How large is the required Minimum Distribution (RMD) from my traditional retirement account? Is that putting me close to any limits or tax thresholds?
o How large might my future RMD be; will it put me close to any of the tax increase thresholds?
Start thinking more specifically about your charitable donation plans. Gifting appreciated assets either directly to a charity/foundation or to a Donor Advised Fund before December 31, 2021 may reduce the impact of the changes to your tax bill.
Consider your estate plans and if you plan to downstream assets consider strategies such as making yearly gifts within the annual exclusion amounts.
Think about contributing to or converting a portion of your IRA to a ROTH IRA where you pay taxes on money going into your account, and then all future withdrawals are tax-free.
Think about the plan for your small business. Understand how the tax changes could impact the sale of your business. The retroactive tax hike can impact businesses in transition. As the sale of a business may easily bump the owner into the 43.4% bracket, it is imperative that those considering a sale of a business meet with their tax advisor.
Your tax, estate and financial advisors can help you develop a thoughtful plan that balances priorities and reduces anxiety and increases control.
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