President Joe Biden’s recently published American Families Plan has long been based on specific ideas such as universal preschool, two years off community college, and paid parental leave.
It also has plenty of information on how Biden would fund the $ 1.8 trillion proposal, including a new top tax rate, an increase in the capital gains rate for millionaires, and additional IRS enforcement of tax ridicules.
Wealthy taxpayers and their financial planners have already braced themselves for the prospect of more taxes and more audits during the Biden administration, but one big question is: what will be the effective date for tax law changes?
The planning details released by the White House on Wednesday did nothing to clarify this issue. This is important for high net worth individuals and their advisors. But it may also be important for investors and even blank check firms keeping an eye on businesses to buy.
Of course, it would be quite difficult for the White House to be certain now of what effective data would be. The American Families Plan is at the beginning of the legislative process and its final content and tax rates, let alone adoption, are not guaranteed.
“We want it to pass as soon as possible,” said a senior administration official when questioning reporters about Biden’s new proposal. “All of this starts with the passage,” added the official.
Biden’s proposal would reset the highest income tax rate to 39.6%, the rate before Trump’s 2017 tax cuts lowered it to 37%. Households earning more than $ 1 million would have a capital gains tax of 39.6% plus a pre-existing tax of 3.8% related to the Affordable Care Act.
Currently, top earners pay a 20% capital gains tax when they sell an investment security that they have held for at least a year.
Until an Effective Date is known, these investors have no time to expire if they wish to pay a lower tax rate. One estimate is that stock markets could sell off $ 178 billion before capital gains surge.
It is common for high net worth individuals to maintain some sort of “capital gains budget” to prepare for tax surprises, said Ali Hutchinson, executive director of Brown Brothers Harriman, a private bank with a very wealthy clientele.
“If you don’t know when and the percentage, then who can manage customer expectations of what capital gains are planned for the next year?” She said.
Biden also wants to end the “top-up” for profits over $ 1 million or $ 2.5 million for married couples. When an asset – such as stocks, art, or other value-adding property – is passed on to an heir, it is reset for capital gains tax purposes.
If the heir sells the asset, the tax is calculated based on the increase in value since the heir acquired it, not at the time of the original acquisition. This allows the heirs to avoid a lot of potential capital gains taxes on something that has greatly appreciated in value over generations.
“The old plan was a simple plan. No accountant was required. It died with it, ”said Hutchinson. But if lawmakers knock down the top-up, older investors may need to think about a possible sale and diversification to avoid passing on a tax bill.
But here, too, they lack a clear schedule of when to act, she noted.
According to White House materials, the proposed changes to the top-up rules will “include safeguards so that family businesses and farms don’t have to pay taxes if they are passed on to heirs who continue to run the business.”
Hutchinson’s customers can already stop thinking about how this could affect their own family businesses, she said.
If there is a sell-off in the market before tax law changes, there may be buyers. Wealthy investors have plenty of cash and are increasingly willing to increase their exposure to the equity markets, a new UBS survey shows. In the meantime, a new group of young retail investors could also be on the lookout for bargains if a tax strategy-induced sell-off creates buying opportunities.
The sales of investments preceded previous rate hikes on capital gains.
Research by the Joint Committee on Taxation of the United States’ Impartial Congressional Committee and the Tax Policy Center, a think tank, showed sales or “realizations” of capital gains increased 60% in the 1986 tax year before a 1987 rate hike. Revenue increased 40% before a Interest rate hike in 2013.
There’s an interesting mix of market ingredients this time around, Hutchinson said. Expedient acquisition firms “hold pools of liquidity and seek acquisitions,” she noted.
None of their business customers want to sell just because there is a prospect of more taxes, Hutchinson said. But for those who are already inclined, the chance for higher capital recovery rates, rather than topping up, is a powerful impetus.
“If I have already thought of its time, why shouldn’t I accelerate this to 2021, as opposed to 2022?” Said Hutchinson. “And there are buyers, there is liquidity.”