Getting Ready for Higher Taxes

Patrick Carlson, J.D., LL.M.

Vice President of Wealth Services

This week’s reader question is about future tax hikes:

What does the Biden tax plan mean for investors? Should I be making changes to my financial plan or portfolio at this point?

The first thing to remember is that all the tax hikes you’ve been hearing about—except those already passed in the American Rescue Plan—need to be approved by Congress. That means any tax code updates may look very different by the time they are fully baked and written into law.

That said, President Biden’s proposed American Families Plan would raise $1.5 trillion over a decade by taxing high earners. For instance, the top individual federal income tax bracket would revert back to the pre-Trump rate of 39.6% (from the current 37%) for individuals earning more than $400,000 a year.

The ceiling on long-term capital gains would rise even more, from 20% to 39.6% for the wealthiest Americans. That bump, which essentially taxes capital gains like ordinary income, would apply to individuals reporting over $1 million in W-2 income, plus gains from selling stocksA financial instrument giving the holder a proportion of the ownership and earnings of a company., bondsA financial instrument representing an IOU from the borrower to the lender. Bond issuers promise to pay bond holders a given amount of interest for a pre-determined amount of time until the loan is repaid in full (otherwise known as the maturity date). Bonds can have a fixed or floating interest rate. Fixed-rate bonds pay out a pre-determined amount of interest each year, while floating-rate bonds can pay higher or lower interest each year depending on prevailing market interest rates. and other assets held in taxable accounts.

If that change is enacted—and at present it’s still in question—there would be instances where we would suggest avoiding taking some of the largest capital gains. In many cases, however, it would not impact how we advise clients. An added wrinkle emerged this week, however. The Biden Administration is considering making any capital gains tax hike retroactive to 2021 earnings. If that happens, a whole new calculus will enter the equation. We’ll keep you apprised.

Another change under discussion—the possible elimination of the “basis step-up rule”—would alter the way capital gains taxes are paid on estates when people pass away. Under current law, upon inheriting an asset, the basis of that asset readjusts to the typically higher date-of-death value.  This minimizes what the beneficiary would pay in capital gains tax if they were to sell the asset upon inheritance. The American Families plan could revise that concept. Upon death and transfer of taxable assets, basis adjustment would no longer be available. Instead, the proposal grants exclusions: $1 million to individuals, and $2.5 million to married couples.

The administration has also floated the notion of raising estate taxes in other ways. An individual today can leave up to $11.7 million to heirs, including lifetime gifts, before the 40% estate tax kicks in. While the rumored change would lower that exemption significantly, the proposal to change estate taxes faces major opposition, and more recent scuttlebutt indicates that this idea has been set aside for the time being.

The last potential tax hike I’ll mention is viewed as the cornerstone of the plan: The corporate tax rate, which would increase from 21% to 28%. While that wouldn’t impact individual or estate taxes, higher corporate taxes can eat into corporate profits and weigh on economic growth.

If that’s the case, you’d think higher corporate taxes would depress stockA financial instrument giving the holder a proportion of the ownership and earnings of a company. prices. Yet, that’s not proven true historically. In fact, going back to 1945, the S&P 500 has averaged a 10% gain during years in which the U.S. corporate tax rate was below 35%—compare that to the average annual 10.3% gain when the tax rate was 50% or higher.

The bottom line is that tax hikes haven’t correlated with poor performance from stocks. Before you make any changes in your financial plan, keep in mind that while death and taxes are certain, the proposed tax hikes are far from assured; many won’t happen in this tax year. As always, please reach out to us with questions about your specific situation—we’re eager to help.

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