The COVID-19 pandemic, and the legislation it spawned, has upended tax planning in a major way. Both legislation already on the books and legislative proposals that may lie ahead from the Biden administration as well as individual lawmakers will all impact tax planners
“We don’t know if the actual legislation will be anything near the proposals, but clearly something will happen,” said Glenn DiBenedetto, a CPA and director of tax planning at wealth management firm New England Investment & Retirement Group. “There will probably be higher income tax rates, and an adjustment to the capital gains tax rate; accordingly, planners should consider specifically accelerating certain gains into what might be lower tax brackets.”
“The maximum rate, which may end up at 39.6%, would be imposed on taxpayers earning over $1 million,” he added. “Capital gains will count toward the $1 million, so with unrealized gains, you should consider managing income to keep it under $1 million.”
A review of a taxpayer’s investments should aim toward making the investments more tax-efficient, according to DiBenedetto. “Municipal bonds are not taxable, so they don’t generate income toward the $1 million. If the taxpayer has stocks with unrealized gains, it might make sense to take and invest them into municipal bonds. That won’t generate the capital gains that some mutual funds do.”
“By donating appreciated stock to charity, an investor does not recognize capital gain, and takes them out of a potentially taxable estate,” DiBenedetto advised. “The Biden proposals do not affect the current lifetime exemption or annual exclusion. But they would likely include the elimination of stepped-up basis, so assets of certain estates would be paying capital gains tax to the extent that they exceed unrealized gain, which is realized at death.”
This has caused concern among small-business owners, he noted: “Their businesses are their biggest asset. If it’s worth $10 million and they sell it in 2022, they may not get preferential capital gains rate. I would hope that any legislation would carve out a once-in-a-lifetime exemption for such gains not to be included in gross income.”
Capital gains and beyond
The end of the lower capital gains rate is the most controversial proposal for users of EY’s Tax Chat, according to Brigette Chip, America’s Tax Chat leader and managing director at the Big Four firm. “The top rate has been suggested to go to 39.6%, the same top rate that might be enacted for income tax,” she said. “And working from home — what could have been one of the most popular ways to reduce income on 2020 returns — is not deductible for employees. The Tax Cuts and Jobs Act eliminated the home office deduction for employees. The self-employed and gig workers can still take it.”
Jim Guarino, managing director at Top 100 Firm Baker Newman Noyes, likened the prospect facing taxpayers as similar to flyers in the Sunday papers promoting sizable savings on particular items: “They have to decide, ‘Do I run out and buy a new lawnmower while it’s on sale, or wait until I absolutely need it, knowing that if I wait the sales price may be considerably higher?’ Some of Biden’s proposals may get some traction. Nearly everyone is confident that any changes won’t be retroactive to Jan. 1, 2021, so that gives us the next six months to make some decisions. Do they want to pull the trigger on a large capital gain, or wait?”
One of Guarino’s clients asked for advice about moving from Massachusetts to New Hampshire to avoid the tax on a very highly appreciated position — to the tune of $2.5 million — with a crypto asset. “We talked about changes in residency and timing. He then asked if he should sell this year, since the federal implications could be four times the state implications. The asset could appreciate another $2 million over the next couple of years, so what he would reap in holding onto and not selling the asset might exceed the additional tax penalty he would have if he sold earlier, just to escape the higher capital gains rate.”
Guarino sees tax practitioners as a family financial physician. “Right now it’s imperative that we take the vital signs of our clients,” he said. “We have to understand their current and future tax brackets, and current income and net worth. And they need to know what taxes are on sale this year, and understand that after the end of the year they may no longer be on sale.”
Kay Lynn Mahue, president of Merit Financial Advisors, agreed. “Right now, most of our conversations and planning are around what the future holds,” she said. “Our clients want to know what they need to do now, knowing that tax changes are on the horizon. A number of our clients have implemented plans using trusts and gifting strategies.”
As an example, she cited spousal access trusts designed to go around the lifetime giving exemption. Spouses gift assets to each other in separate trusts. Since the strategy is based on full, irrevocable trusts, there has to be a well-established marriage where the parties are confident with each other. “Second and third marriages, and newlyweds, should not utilize this vehicle,” she said.
Mahue noted that a number of clients are thinking about selling their businesses.
“We’ve had a high level of inquiries about selling accounting and financial services practices,” she said. “If they have a succession plan, we have seven months left in the year and this may be the best time to do it because of the proposed capital gains tax increase. If you work with business owners that are at the sunset of their career, you should definitely be having this conversation — don’t wait until October where there’s not enough time to get all your ducks in a row. They could end up paying more than double in tax, so it will greatly impact what they have left over.”
Rate raise ahead?
“The proposed raise in the corporate tax rate from 21% to 28% is eye-opening,” observed Robert Conzo, managing director of The Wealth Alliance. “That’s a 33% raise. And as corporations go back to doing more business outside the U.S., the administration has suggested a global minimum tax to combat this.”
“Part of the debate around Biden’s proposed tax hikes will be whether raising taxes could derail the economic recovery, and to what extent,” Conzo said. “I tell our clients that it’s hard to plan around a situation that has so many question marks associated with it. We can discuss the situation and come up with concepts, but it’s not prudent to put a plan in place when much is not yet solidified.”
Roger Harris, president of Padgett Business Services, agreed. “If you know what the future is, it’s easier to plan for it,” he observed. “People want to know, ‘Should I sell stuff, what if the capital gains rate goes up, what happens if I die, will my kids get a stepped-up basis?’ It’s important to know what the proposals are, but it’s just one more thing to consider after a year or two of confusion and constant change.”
None of this may happen, he added: “The reality is the proposals have to pass the political test — who knows what kind of horse trading will happen? What I tell our offices is to plan based on what you know, but you have to be prepared for what you don’t know.”
