President Biden has proposed an increase in the tax rate on capital gains and dividends for the EU … [+]
Last July, I wrote an article about what to do about the proposed tax hikes if there is a blue wave and Democrats are supposed to take over the presidency, House of Representatives and Senate in the November 2020 elections.
While it wasn’t exactly a blue wave, Joe Biden was elected president and the Democrats have tight control over Congress. That means tax hikes are likely in 2021.
On Wednesday, President Biden announced his American family plan, which outlines his tax hike agenda for the rich. During his campaign, Biden pledged to raise taxes so that the richest Americans should shoulder more of the tax burden by “getting investors to pay the same tax rates as employees and ending expensive and unproductive tax loopholes.”
What Biden proposes in his American family plan coincides with what he put forward as a candidate:
- Increase tax rates for those earning more than $ 400,000 from 37% to 39.6%
- Tax capital gains and dividends at the normal income tax rate of 39.6% for individuals with income greater than $ 1 million versus the current tax rate of 20%
- Eliminate the base increase on death for wins over $ 1 million (or $ 2.5 million per pair).
The only surprise in the plan announced this week is the lack of changes to the estate tax. As a candidate, Biden had stated that the current estate and gift tax exemptions of $ 11.7 million were too high and should decrease to between $ 3.5 million and $ 5 million by the Obama presidency. The American Families Plan leaves the $ 11.7 million exemptions untouched and bypasses other popular Democratic estate planning reforms, such as limiting the use of valuation discounts to lower estate taxes. Another good news for the rich is that Senator Elizabeth Warren’s annual property tax of 2% to 3% is not part of the proposed changes.
What will the new tax law look like?
The American Families Plan is just a starting point for negotiation. Predicting what a new tax law will ultimately contain is difficult as all horse trading takes place before the law is finalized. For example, under former President George W. Bush, inheritance tax exemptions were $ 3.5 million in 2009 and zero in 2010. Inheritance tax and gift tax exemptions are expected to decrease to $ 1 million each in 2011, and President Obama’s comments are that the $ 3.5 million exemption level was too high and it was widely believed that it would fall. In December 2010, President Obama and Senate Majority Leader McConnell announced they had negotiated a new tax package that would increase estate, gift, and GST tax exemptions to $ 5 million each in 2011. This shocked the wealth management industry. Nobody predicted that the exemptions would stay at $ 3.5 million, let alone increase to $ 5 million. So what happened I’ve heard from multiple sources that McConnell said behind closed doors that he would let the Senate ratify the START treaty that Obama negotiated with Russia in exchange for the higher tax exemptions. I think about this story every time I read a prediction about what future tax legislation might look like.
Given the caveat of not knowing what the final tax charge will include until it is passed, it is likely that the top tax rate will increase from 37% to 39.6% and tax rates on dividends and capital gains will increase 25% by 28 %.
Biden’s proposals to raise capital gains rates to normal interest rates and eliminate the base hike are more difficult to sell as some moderate Democrats have raised concerns. While not currently part of Biden’s plan, provisions to increase the estate tax by reducing exemptions or limiting the use of valuation discounts due to their popularity with Democrats could be included in a final bill.
When would a new tax law come into force?
While a tax law is theoretically possible retrospectively as of January 1 of this year, the changes to the tax law will most likely take effect at the time of entry into force or from 2022. None of the tax laws introduced by the Democrats so far this year has a retroactive date. Additionally, it would make sense for the government to allow some time between the entry into force of the new law and the entry into force date, as this would allow wealthy taxpayers to earn profits now at lower rates, which in the short term translates into an increase in federal revenue from the on these taxes levied would result in profits. Having different tax rates for different periods of the year would also be an administrative nightmare for the federal government, tax advisors, and custodians.
What should i do?
No matter what, the most important thing is to have a plan. Since the current tax proposals are similar to what we expected last July, my advice remains the same strategies I outlined in this article. These are essentially about:
- Take profits before you die so that your heirs get the full base fortune. The benefit of this planning is that the income taxes you owe on the profits reduce the value of your estate and, therefore, the amount of estate taxes due.
- Accelerate income realization. You can do this by converting your traditional IRAs to Roth IRAs, selling valued assets now to fund your future spending needs, purposely making profits in your irrevocable grantor trusts, and choosing not to defer any income into your deferred compensation plan.
- Postpone prints. Two other good strategies are to postpone charitable deductions for years to come or forego an accelerated depreciation of your tightly run business.
- Structure your investments to reduce your future tax burden. Using lower tax-realizing investments such as index funds or investment managers and investing in life insurance policies can also provide significant tax benefits.
- Be ready to give away the unused portion of your $ 11.7 million inheritance and gift tax exemptions. Although Biden’s tax proposals do not include a reduction in tax exemptions on transfers, the tax laws introduced by the Democrats earlier this year cut tax exemptions to $ 3.5 million or less. Therefore, it is possible that reduced exceptions are part of a final invoice. Also, keep in mind that these exceptions will decrease to $ 5 million after 2025 and are adjusted for inflation. Hence, a gift plan is essential.
Since every taxpayer has their own financial situation, there is no one-size-fits-all solution. However, if you let your financial, legal, and tax advisors work out the numbers for your situation to figure out what to do now, you can prepare for whatever happens.