It’s no secret there are changes coming to the tax code. President Biden’s tax plans are still in development, but even if we see nothing out of Washington, most of the lower tax rates set under the Tax Cuts and Job Act of 2017 are set to expire at the end of 2025. When this happens, we can expect to see changes to individual income taxes and the estate tax. However, President Biden has made it clear that he would like to see more changes to the law even before that timeframe.
At the bottom of this article, we have listed our solutions for lowering taxes, and some key takeaways for you to think about.
So, what is expected under President Biden’s proposal and what can be done now to lower taxes in the future?
While we don’t know exactly what the final version will look like, we do know change is imminent. President Biden noted in April 2021 when he unveiled the principles in his Made in America Tax Plan that “debate is welcome, compromise is inevitable, changes are certain.” We anticipate a lot of wrangling will occur on Capitol Hill over the proposed changes and we will be watching this closely.
To accompany the Made in America Tax Plan, President Biden has introduced the American Jobs Plan to focus on rebuilding infrastructure and create jobs and the American Families Plan that focuses on American families and communities. Each of these programs are expected to be funded by notable changes in tax law. We will outline what has been proposed and what is already enacted.
Funding The Proposed American Families Plan
On April 28, 2021, President Biden announced the American Families Plan which has an estimated price tag of $1.8 trillion and funded by proposed taxes on the wealthy.
As expected, President Biden included a capital gains tax increase for millionaires in his American Families Plan. Currently, if you sell stocks, mutual funds, ETF’s or other capital assets that you held for at least one year, any gain from the proceeds is taxed more favorably at either a 0%, 15% or 20% depending on your income. The higher your income, the higher the capital gains tax rate, but, under current law, the most you would ever pay in long term capital gains taxes is 20%. If you sell taxable investments for a gain that you did not own for at least one year the gains are taxed at short term capital gains rates, which is currently your ordinary income rates and can be as high as 37%.
For information on the current capital gains tax structure, please click here
In addition to capital gains taxes, there is currently an additional 3.8% surtax on net investment income (NII) that you might have to pay on top of the capital gains tax. Net investment income tax is paid on things like taxable interest, dividends, capital gains, passive rents, annuities and royalties. You are assessed this additional tax if you are a single filer and your income is over $200,000 or married, filing jointly with income over $250,000. Use form 8960 (Click here for a link to the form) to calculate the surtax.
President Biden has proposed an increase to the top long-term capital gains tax rates on anyone earning more than $1 million a year to the same level as their marginal income tax rate. In addition, the marginal ordinary income tax rate for people at this income level would increase to 39.6% (from 37%). When the net investment income tax is factored in, investors earning more than $1 million or more could see their tax rate on capital gains jump to 43.4% under this proposal. This represents an increase of 19.6% over the current maximum tax.
One big change we anticipate making it through is a reduction in the estate tax exemption. Currently, the estate tax exemption is $11.7 million per person and $23.4 million per couple. This means a couple can die and leave $23.4 million to their heirs without the beneficiaries paying any taxes on the windfall. We would expect that this exemption amount will go down, but, to what level is anyone’s guess and will be the subject of a lot of debate in Congress. Senator Bernie Sanders has proposed restoring the 2009 thresholds of $3.5 million per individual and $7 million per married couple.
In addition, larger estates would be subject to higher tax rates. Currently, any assets above the current estate exemption are taxed at 40% of their value. Senator Sanders has proposed increasing the tax rate to 45% for anything above the $3.5 million and $7 million exemptions. Also, he has proposed that taxable estates over $10 million would be taxed at 50% and amounts greater than $1 billion would be taxed at 65% according to the Joint Committee on Taxation. The same rates would apply to gift taxes and that threshold would be reduced to $1 million.
Additional Proposals: Step-up in Basis, Carried Interest and Real Estate Exchanges
The American Families Plan also targets other areas of the tax code that the President refers to as “loopholes” such as the step-up in basis rule. Under current law, the step-up in basis rule enables you to pass down assets to the next generation without your heirs paying tax on the gain. The cost basis (what you paid for the asset) gets “stepped up” to its current market value on the date of the owner’s death. Thus, whoever inherits your asset can sell it and not have to pay any taxes because the basis has increased to market value on the date of death.
However, the Biden Administration has announced that family-owned farms passed down to family members who will operate the property will be protected with respect to this change. Additionally, gains will not be taxed when appreciated property is contributed to a charity. To accompany this proposal, we would anticipate a change to your ability to take advantage of 1031 exchanges on your real estate holdings.
Currently, you can sell an investment property and purchase another one within 45 days to avoid paying capital gains on the sale. You can defer gains on your real estate holding by trading up in this way. When you die, the step up in basis enables you to pass on a property tax-free. Under the plan, the deferral would end for capital gains in excess of $500,000.
Funding The Proposed American Jobs Plan
On March 31, 2021, President Biden proposed the American Jobs Plan which would increase income taxes on corporate profits. The tax increases would help to pay for the proposed infrastructure improvements that have an estimated cost of $2.3 trillion.
The corporate tax rate would go from the current level of 21% up to 28%. To give you context, the corporate tax rate used to be at 35% (between 1994-2017). Pundits observe that companies did just fine so a change to 28% should not be enough to drag them down. Still, an increase in the tax rate will potentially reduce profitability which can affect valuations.
The Biden administration has recommended a new corporate minimum tax of 15% on book income to prevent companies from avoiding U.S. taxation. Also, the U.S. would levy a minimum tax of 21% on multi-national company income. The minimum tax would apply on a country by country basis but the goal is to prevent companies from avoiding paying tax in the U.S. Also, deductions for the expenses of having jobs off shore would be eliminated and tax credits would be granted for having jobs onshore.
One of President Biden’s goals is to discourage U.S. companies from moving jobs, intangible assets and profits overseas to countries with lower tax rates than the U.S. In addition, the President is trying to establish a global minimum tax to prevent some countries gaining a competitive advantage by cutting corporate tax rates. We don’t know if this will gain traction but it’s in the works.
Regardless of what gets passed, you should expect more regulation and oversight from the IRS. President Biden has made it clear he intends to increase funding to the IRS in order to increase enforcement of tax law compliance by corporations and high-income individuals. Increased auditing and greater enforcement are projected to raise tax liabilities by several hundred million dollars that currently go unpaid because of under-enforcement resulting from inadequate IRS funding. The President is also calling for strengthened government oversight of tax preparers.
While we don’t know for sure exactly what the changes will look like we are preparing for change that is inevitably coming. Stay tuned for more in the coming months as we follow this.
Knowing that tax increases are on the horizon, makes it more important than ever to take advantage of strategies designed to lower your tax liability. Roth Conversions are a great way to take advantage of todays lower tax rates and potentially save yourself a lot of money in the future.
Be strategic in realizing gain on assets that you anticipate selling in the near term to take advantage of lower capital gains tax rates and the potential dissolution of the step up in cost basis.
Consider using 1031 Exchanges on real estate investments while you still can.
Additionally, strategies like Tax Loss Harvesting will become even more valuable if you expect to find yourself in a higher tax bracket in the future. Regardless, you can have the confidence to know that your team at Seaside Wealth Management will be staying at the forefront of ways to reduce your tax bill in retirement.
Our Key Takeaways