The winds of change are blowing when it comes to taxes, and it seems they're blowing against wealthy clients.
The new American Families Plan, for instance, combines $1 trillion in spending with $800 billion in tax cuts and credits for middle- and lower-income families, along with education and childcare initiatives. To help finance these, the plan includes a bump in the top tax rate and the capital gains rate to 39.6%.
“An almost 100% increase” with the latter, noted Bruce Primeau, a CPA and president of Summit Wealth Advocates in Prior Lake, Minn.
Although thresholds for different classifications of filers remain unspecified, the administration has said that generally no one making less than $400,000 (perhaps less for individual married filers) would see their taxes rise. Polls show that most Americans support such tax changes.
The consensus is also that American Families or future legislation resembling it may sock wealthy clients especially hard. How should advisors and their wealthy clients respond to this?
“Democrats are throwing everything at the Republicans in hopes of getting some of what they want,” Primeau said. “I’ve been touching base with my clients that will be the most impacted to discuss potential strategies should some of the bigger-ticket items actually get passed. The best I can do is advise those clients to be prepared to implement some specific strategies before Dec. 31, assuming that the changes being proposed will be effective for 2022.”
“We’ve been telling clients for a while that this is coming,” said Mark Bosswick, New York-based co-managing partner at Berdon LLP, adding that the ending of the step-up in basis and the change in the capital gains rate are the biggest potential hits for wealthy clients.
“The American Families Plan may have multiple impacts on the planning for owners of family businesses, who may be forced to make a now-or-never decision on the future of their business. Should they exit the business under the current favorable capital gains regime or update their business succession plan to ensure their heirs continue to run the business in perpetuity to avoid the tax implications of eliminating the stepped-up basis?” asked Timothy Laffey, head of tax policy and research at Rockefeller Capital Management in Philadelphia. “Effective planning will depend on the unknown nuances of actual legislation.”
Eliminating the step-up in basis “is going to cause a lot of consternation for folks that have assets they’ve owned a long time and that have appreciated considerably,” Primeau said. “Currently, at [the owner’s] death, the cost basis of those items steps up so that they can be sold at little to no tax impact. If the step-up is eliminated, some folks are going to pay an awful lot of tax.”
What may be more notable, Laffey said, is what isn’t in the tax plan, such as changes to the transfer tax regimes (estate, gift and generation-skipping transfer taxes). “One is left to wonder if this was a strategic plan by the Biden administration for negotiation purposes, or if overhauling the transfer tax regimes won’t be a priority of the administration,” Laffey said.
“The issue is, what will this do to our economy?” added Dan Henn, a CPA in Rockledge, Fla., referring to the proposed rate increase in long-term capital gains for the wealthy. “The market would expect to take a dip right before this law took place.”
“There’s not much else we can do but vote,” he said. “It can potentially sway certain decisions when it’s in a tax bill that’s gaining steam.”
“As of now, real estate is still the best tax-advantaged asset class,” Bosswick added, recommending that high-net-worth clients should “maximize their wealth transfers as soon as possible.”
“Be prepared to act quickly,” Primeau said. “I’m not of the belief that the Democrats are going to get everything they are asking for. Plus, we’re just four years away from a potential change in administration. A lot of what may be passed this year could be undone in a few years.”