The greatest wealth transfer in U.S. history is underway. Americans age 70 and older hold an estimated $35 trillion, according to Federal Reserve data.[1] This means that over the next several decades, millions of Americans will be contemplating how to distribute their life savings to heirs, charities, and other beneficiaries. To make matters even more interesting, wealthy Americans also face the potential for a once-in-a-generation increased tax liability. The Biden Administration has proposed increasing taxes on wealthy Americans to raise revenue for various spending initiatives.
President Biden has proposed raising the long-term capital gains tax rate from 23.8% to as high as 43.4% for individuals earning more than $1 million annually. In addition, Biden has proposed eliminating the step-up in basis for inherited assets.[2] This is all subject to change, and Congress has yet to begin debating these proposals in earnest. But it’s not too early for individuals to begin planning for how their investment and wealth-transfer strategies might be affected by higher taxes on capital gains.
Historical Perspective on Capital Gains Taxes
The long-term capital gains tax rate has been a source of heated debate for decades. Advocates for more progressive taxes characterize the capital gains rate as a loophole for the wealthy, as it affects those who own investments such as stocks and bonds. As political winds shift, the capital gains rate tends to end up under the microscope. Rates have varied from as high as 40% to as low as 15% for single filers or households in the highest tax brackets. The rate has been lower, or even zero, for individuals and families in lower-income brackets.
Source: Tax Foundation, https://taxfoundation.org/federal-capital-gains-tax-collections-historical-data/
Should Proposed Tax Changes Drive New Strategies?
With the specter of increasing capital gains taxes on the horizon, many investors are wondering whether they should make any changes to their investment and wealth-transfer strategies now. In particular, investors may be thinking about ways to liquidate or gift highly appreciated assets in a way that avoids the higher capital gains rate.
Some investors may be tempted to sell appreciated securities now before capital gains rates increase. This approach has some merit, but it also has important flaws. First, the new capital gains tax rate may be applied retroactively, which could negate any potential advantage of proactive selling. Also, at this point, changes to capital gains taxes are simply proposals, so it is unclear how significantly the capital gains rate will actually increase. It is also unclear whom the changes will and won’t affect — Biden’s proposed $1 million income threshold could be open for negotiation.
Other investors may look to limit capital gains exposure by taking advantage of the step-up in basis rule. Under current law, when an individual inherits an asset, the asset’s tax basis “steps up” to its value at the time of the donor’s death; thus, the inheritor avoids having to pay capital gains on the change in value since the donor purchased the asset. For example, if your father bought a house for $100,000 in 1970 and passed the house to you upon his death when the house was worth $1 million, you would only owe capital gains taxes on any increase in value above $1 million. But if Biden’s proposal to eliminate the step-up in basis is enacted, donors’ estates would owe capital gains on appreciation above an exemption amount.
Talk to Your Advisor About Tax-Aware Strategies
The uncertainty related to these proposed tax changes highlights the need for ongoing conversations with your wealth advisors. Generally speaking, investors shouldn’t let tax decisions be the primary drivers of investment decisions. But there are instances when tactical repositioning makes sense. Your Machen McChesney advisor can help you think about these opportunities and the options available to you.
In addition to potential changes to capital gains taxes and the step-up in basis, there are a host of other tax changes on the docket as the Biden administration seeks to increase revenue for various spending initiatives. We covered several of these, as well as a few potential tools to help manage your tax exposure, in our recent article, “Key potential changes under President Biden’s tax plan.”
To discuss how potential tax changes may affect you and your family’s unique situation, please reach out to your Machen McChesney advisor.
For more information about the above article or other wealth management services, contact Marty Williams, CPA at (334) 887-7022 or by leaving us a message below.
This article originally appeared in BDO USA, LLP's Insights/Advisory/BDO Wealth Advisors - July 2021. Copyright 2021 BDO USA, LLP. All rights reserved. www.bdo.com.
[1] The Wall Street Journal, “Older Americans Stockpiled a Record $35 Trillion. The Time Has Come to Give It Away.” July 2, 2021.
[2] The Wall Street Journal, “Biden’s Capital-Gains Tax Proposal Puts Estate Planners to Work,” June 8, 2021
