How a capital-gains tax hike would hit advisors — and what they can do about it

Not just the uber-wealthy are stressing out over President Biden’s plan to raise taxes on investment profits. Many independent financial advisors are also in those crosshairs if they aim one day to sell their practice or pass it on to heirs.

Biden’s plan to nearly double the capital gains rate for those making at least $1 million has elicited howls from hedge fund managers and high net worth Americans, who have reaped massive gains from the stock market’s boom over nearly a decade.

Lesser noticed: the proposal would also hit small-business owners of all stripes who make a good income but have not yet cashed in on the millions of dollars of profits that would come from selling their business or leaving it to heirs. With financial advisors skewing older— the average age is 55, with one in five aged 65 or older, according to J.D. Power — and a wave of retirements in the industry looming, the proposed tax hike may spur RIAs to sell their firms quickly.

“The thoughtful ones will definitely explore selling their practices, perhaps at a discount,” says George Ball, the chairman of Sanders Morris Harris, an independent broker-dealer and RIA in Houston. “You will see much more outreach by advisors to investment banks or private equity firms, as opposed to the advisors waiting to be contacted. It’s, ‘Given the tax things and given my age, do you wanna talk?’”

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Biden’s tax-the-wealthy calls, which have included taxing assets at their value when passed to heirs, not at their lower value when bought years earlier, are expected to come this week as he prepares for his first address to a joint session of Congress on April 28.

The current long-term capital gains rate of 23.8% (including the 3.8% Obamacare surcharge) for stocks, property and other assets sold after one year would rise to 43.4%. That amount reflects the 39.6% rate that Biden has also proposed raising the current top individual rate of 37% to, as well as the Obamacare levy. In high tax states like California, where the top individual rate is 12.3% and a one percent “mental health services” levy falls on those making over $1 million, the total tax bill could thus be nearly 57%. Biden has also called for higher taxes on those earning more than $400,000 a year.

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His proposals still have to pass muster with Congress, and would likely face at least some degree of a fight.

Still, “clients are absolutely freaked out,” says Alan Becker, the president and CEO of Retirement Solutions Group, an RIA in Overland Park, Kansas. “People are scared.”

And not just clients. The tax hike could rapidly alter the calculus of succession planning for independent advisors.

Client account and relationship managers at RIAs make on average $64,000 to $240,000 a year, including cash compensation and owner profit distributions, according to the most recent data from Schwab. Those in an investment role average $65,000 to $170,000. And the median revenue at RIAs ranges from $436,000 (for firms with AUM of less than $100 million) to $2.2 million (AUM of $250 million — $500 million) and then consistently upward, reaching $7.8 million (AUM of $1 billion or more), says Schwab.

RIAs, in a wave of consolidation sell on average at seven times’ their EBITDA (earnings before interest, taxes, depreciation and amortization), a measure of profitability that is typically lower than revenue, according to Fidelity. That puts RIAs of any size, as measured by AUM, in the category of those affected by Biden’s proposal. “There’s going to be a lot of M&A — people will rush to move closely-held business or assets with capital gains,” says Dustin Grizzle, a CPA and tax partner at MGO, an accounting firm, in Boca Raton, Florida.

Like their business-owner clients, advisors are waiting to see if a change to the capital gains rate would apply from the start of this year. The stock market has seen a steep 50% rally during the last 12 COVID-plagued months. While backward-looking tax changes are not common, they're not unheard of. “The biggest outstanding issue is, can they make this retroactive?” says Grizzle.

What to do? “There are tools that you can use to control” the impact of steeper taxes on investment profits, says Paul Axberg, a CPA and CFP and the founder and president of Axberg Wealth Management, an RIA in Sun City West, Arizona. For instance, he says, advisors can sell a firm in installments, to avoid tripping up income limits, as well as use trusts: “I think it’s an opportunity.”