The Adviser You Can Talk To Podcast
June 2, 2021
Death and taxes may be certain, but the form each takes is a lot less so. And when it comes to taxes, some forms are worse than others. In this episode, some of Adviser Investments’ wealth management experts decode what we know about the Biden administration’s proposed tax hikes and how painful they’ll be, including how the changes may impact:
Most importantly, the team also offers some thoughts about how strategic financial planning may help lessen the sting if these tax hikes come to pass.
Congress has yet to approve these proposals, and a lot may change before any become law. But it’s wise to be prepared. Click above to listen now, and read our recent blog post on this issue for even more detail.
What does the Biden tax plan mean for investors? Should you be making changes to your financial plan or portfolio at this point? Listen to this episode to get our thoughts.
Hello, this is Andrew Busa and I’m a financial planner here at Adviser Investments. And we’re here with another Adviser You Can Talk To Podcast. Today, I’m joined by two of my colleagues, Patrick Carlson—he’s a vice president of the wealth services team here—and Rick Winters, who is a vice president and he also manages many client relationships at the firm.
Andrew, great to be here.
How you doing, Patrick? Good to see you, Andrew.
It is wonderful to have you both. Today’s episode is somewhat of a special edition. We’re focusing on what the Biden administration put forth as part of the American Families Plan back at the end of April. And with this plan here, this included legislation for education and childcare, that’s not what this episode is going to be getting into. We’re mainly going to be talking about the tax ramifications of this proposal.
That’s a great point, Andrew. The legislation is huge. It’s broad. It has a lot of different components and it also has not yet been passed. We still don’t know what the final form of this is going to look like. Today, we’re just talking about a couple of the high level kind of tax impacts that we’re going to have. There’s obviously a spending component and some other parts of this bill as well, but that’s a subject for another day.
Yeah. Just consider this an appetizer to a further main entree as we get through the rest of the year. This is, and I know I can speak for you guys, something that we’ll be excited to do is actually come back and give you facts to work with and real planning strategies.
Yeah, absolutely. I think it’s a timely episode because we have gotten questions—I know the three of us have from clients—on what a potential tax proposal would look like, how will this affect your taxes this year. Those are some of the things we’ll be getting into. High level, we’re really going to cover four things in today’s episode. Proposed changes to the income tax is first. Number two, we’ll cover proposed changes to capital gains tax and basis adjustment. Third, we will hit on any proposed changes to the estate and gift tax. And then finally, sort of a summation of any financial planning opportunities that you should be taking advantage of with the information that we know now.
Before we dive into those topics, I do want to lead off with a question that’s come up pretty frequently and I’ll tip it to you guys first. And I know there’s not a clear answer on this, but I’d just be curious to get the discussion going. What are your thoughts on whether these proposals, if and when they’re passed, would they affect someone’s 2021, this year’s taxes?
Yeah, Andrew, it’s a great question. And unfortunately just don’t know at this point. The bill could be retroactively applied, where they say, “Gosh, we’re going to change the rules back to January 1st, 2021.” The rules could be applied mid-year, [which means] some random date later this year becomes the date when all the rules change. Or, what I think is probably the most likely outcome—just because this still has to pass Congress and all those representatives and senators have to go back and explain this to their constituents—it’s probably going to apply going forward. We’re probably thinking it’s going to be January 1st, 2022, but we really do have to be prepared for anything.
Yeah, I would agree. My conversations with clients and the other professionals that we work with, their accountants, their estate attorneys, is that we just want to be prepared for what might happen. We can’t say with confidence that there won’t be any retroactive tax being applied. It would be very uncommon and unlike the historical precedent that’s guided us. I think we’re looking at a situation where we can just make sure we’re planning and look for some of these changes to take place in 2022.
Yeah, for sure. And as we said in this introduction, as the law starts to crystallize and gets passed, if that turns out to be the case where there’s some kind of retroactive pieces of the bill, we’ll absolutely talk about that in our next episode and with clients as part of our planning opportunities.
With that, let’s get into the main topics and we will start off with proposed changes to the top individual income tax rate. Patrick, I’ll let you lead off with this one.
Well, thank you, Andrew. This is perhaps one of those big headline kind of numbers, right? Because we hear that the tax proposal is going to return us to the tax rate for the top earners that existed before the Tax Cuts and Jobs Act in 2017. And so this would be a change from 37% to 39.6%. A relatively modest tax increase on high income people, but perhaps a meaningful one when we start considering the dollar amounts involved. Now, President Biden has said that he does not want to raise taxes on those earning under $400,000. That’s kind of been the dividing line in this round of tax policy debate between the two parties, here. And that presents some interesting questions that are kind of open at this point, in terms of the reform. If you’re a single filer, you might actually be in that up to about $400,000 of income and you would actually currently be in a bracket that would be lower than that.
If we try and reconcile this stated intent to not raise taxes on those making under 400,000, with the change in that top rate, there may need to be some change to the brackets to accomplish that. Again, we don’t know how exactly they’re going to do that in the code, or whether in fact there might be potentially some tax increases on a few people under 400,000, but that’s sort of where we’re at. And the thing that we’re watching most carefully is how is this going to play out between married, filing joint taxpayers; married, filing separate; head of household and singles? How does this $400,000 number that’s been proposed, how does that work?
Yep. I was about to say that. It’s been unclear up to this point, the filing status, how that would affect, right?
Correct. We just don’t know yet. And it’s one of those things where the filing status, a lot of times it’s based on, are you married or are you not? There’s not a lot of room to plan around that, but for some clients—we saw this with that unemployment change that happened with the American Rescue Plan, which actually already did become law—where for some clients, it made sense to file separately to take advantage of that unemployment exclusion. There can be some planning opportunities from time to time, but in general, there really aren’t.
From a change standpoint, we know 39.6%, while that is a change, It is a higher tax, it is a number we saw back in 2017 tax filing. So it’s not a new number. It’s not the biggest change that’s being proposed.
Yeah. No, exactly. That’s a really good point is that sometimes we can get caught up over how higher taxes are going to go, but it’s really just a return to that 2017 pre-Tax Cuts and Jobs Act of 39.6. Well, good. Let’s transition into, so that’s income tax, high level on what the change would be there, but let’s talk about proposed changes to capital gains tax and basis adjustment. And within these topics, I think are more of a major shift in our tax regime. Wouldn’t you guys say?
Yes, absolutely. As you look at what we’ve all become accustomed to, the cap gains rates have been pretty consistent, well with minor changes, but pretty consistent over the last 20 years or so. This would be a substantial change, especially for anyone that’s relying on capital gains or dividends for income. And what we’re looking at is it eliminates preferential long term cap gains for income over a million. Now that does affect a small portion of the population, but people who are earning over a million dollars would be watching a capital gains rate go from 20% max cap gain rate to 39.6 in this proposed rate adjustment.
Which if anybody was getting a dollar before, it only gets a cut into that, that would almost be a doubling of that. You’d be cutting that after tax down to almost 60 cents.
That would effectively double the rate, as I was just saying for cap gains over that million dollar mark. And also [don’t] forget that there’s this still the surtax of 3.8%. We’re not done there. That would push you up all the way to 43.4%. A significant tax change. That may play a lot more into some of this 2021 planning, in anticipation of some of the things we may be seeing in 2022.
Right. This one is very clearly aimed at the small percentage of very high earners in this country. But for those people, this is like you said, Rick, a significant change.
And sort of along those same lines, when we think about how we realize capital gains, one thing that’s been a pretty, well, a constant in our tax code has been this idea of a step up in basis or more broadly, a basis adjustment when someone passes away, and those assets are inherited by their beneficiary. Patrick, I wonder if you could kind of take us through, high-level, how that works currently and what the new proposal on the table is.
Yeah, absolutely, Andrew. The idea of the basis adjustment—and you’ll commonly hear it called basis step up—is that when a person passes away, all of the assets that they own, so if I own a 100 shares of ABC Company stock and I paid a dollar a share for ABC Company, I have a $100 of basis. If at the time I die, it’s worth $10 a share, well, if I were to have sold that the day before I die, I would have a large capital gain. And as Rick just mentioned, if I’m over a million dollars, that capital gains rate would go up substantially. What the basis step up rules have done, historically, is when I pass away the heirs that receive that ABC Company stock, they get it, they get their basis to be equal what it was worth on my date of death. If it was worth $10 on my date of death, they’re able to sell that stock and pay no capital gains tax.
The Biden administration proposal changes this rule completely. What it does is it allows a limited amount of basis adjustment up to a million dollars total. To basically keep the old rules for up to a million dollars of gain. But over a million dollars of gain, now my heirs are going to have to pay capital gains tax on those stocks and other assets when they sell them.
The reason that’s really important is because when we layer these two rules together, we have the potential for there to be a massive tax increase on those who inherit appreciated stocks. And under current law, still you’d have the estate tax to deal with, but under current law, at least you get that basis adjustment so we don’t have to worry about a capital gains tax. But if this proposal were to become law, you’d have to pay an estate tax and you’d have to pay a big capital gains tax. It could substantially alter a lot of estate planning and require a lot of revisions to some estate plans in order for them to remain tax optimized.
Yeah, absolutely. Patrick, if I can jump in, it’s Rick. One of the things that we don’t need to dive into too deep here, because again, this is all just in thought. Real estate, that’s going to be a major play on your estate planning. Just keeping that in mind. When you think about these tax laws, it doesn’t just affect your stocks, your bonds, your mutual funds. It will play on how certain other assets, businesses or real estate will pass on to that next generation as well.
Absolutely. And that million dollars has to be spread across all of your assets. You don’t get a million for your stocks and a million for your business and a million for your real estate. It’s a million total if the proposal were to become law.
Yeah, that’s a great point. Kind of speaking of real estate, so functionally, this basically works the same way currently, if you think about selling your home and you qualify for that exemption, if you’re married, filing jointly, you can exclude $500,000 of that gain when you go to sell your home. Basically it would function the same way, yeah?
I don’t believe there’s any changes to the exclusion for the sale of your home. It would be the mechanics that we have for this basis adjustment thing. We actually have echoes of 2010 when we had the temporary repeal of the estate tax and there was similar rules in effect. They’re kind of just resurfacing those and proposing to bring them back in a more broad way.
Got it. Perfect. Let’s move on to the third layer here. We’ve talked to their income and capital gains taxes. Let’s hit on any proposed changes to the estate and gift tax. Patrick, you’re our estate planning expert here, I’ll let you lead off, but Rick definitely feel free to jump in as well.
For sure. Thank you, Andrew. Curiously, at least for me, there were actually—other than that step up change, which is very significant—there’s no changes proposed for the estate tax exemption or the rate as part of the plan. And I suppose in a way that kind of makes sense because when they did the Tax Cuts and Jobs Act, which raised the estate tax exemption to two $11 million indexed for inflation, it’s currently 11,700,000 per person in 2021. When they did that in 2017, they included what’s called a sunset. And what that means is that the law automatically expires at the end of 2025.
Even if President Biden and Congress do absolutely nothing, these higher estate tax exemptions go away on their own. Perhaps this is just their acknowledgement, perhaps a bit of some political reality to say, “Gosh, is that the hill we want to die on?” And they say, “You know what? That’s not the hill we want to die on. Instead, we want to fight about something else and we’ll just kind of leave that one alone.” That’s what I think is interesting about this, is there’s no real change here. Other than again, that potentially a significant change on the basis step up rules that’s proposed that we just talked about moments ago.
I think one of the main things is just like you said, Patrick is, there’s not enough money in it between now and when it sunsets under the existing law to try to put it, why not? Because it’s going to immediately be labeled and the whole death tax conversation comes back up and you start seeing one party labeling the other. I think this is kind of that—best to just lay off and focus our attention elsewhere and try to avoid those more distracting labels. Even though, compared to history, even 5.5 or 5.4 million is a pretty large number compared to what it historically has been.
Absolutely. And I think that’s a great point, Rick, that you mention there. Follow the money. The estate tax has never been a huge revenue raiser for the federal taxes, but the capital gains tax, the income tax, yeah, those are where almost all of the revenue comes from. It’s in a way it’s hardly surprising that the proposal is heavily focused on those and basically doesn’t really do anything to the estate tax.
Yeah. And I was personally surprised by this, at least so far, because I know we had received some questions about what if the estate exemption goes down? How should we plan for that? But again, like we said, no changes thus far seen in the proposal. This is all subject to change, but that’s what we’ve seen. Given the information that we do know sort of right now, what are some planning opportunities that you both are considering. Sort of, again, before the law is passed, we know that, but right now should we be taking action?
I’m going to jump in right away because I don’t want to lose mine first, which is one of the things I focus on all the time. And it’s not just because of the proposals for the new tax law, is Roth conversions. And if we’re going to see a potential tax change, a rate change, you do have to couple this in with some of your other financial planning, your overall estate plan, but Roth conversions in 2021 at the lower tax rates.
Yeah. Yeah. I think that’s a good one. And sort of to piggyback onto that, I’ll just touch on the idea of harvesting gains and potentially deferring losses into future years. The idea, harvesting gains from invested assets could be more of an incentive to think more seriously about that, while tax brackets are lower, capital gains rate is potentially more favorable than it’s going to be so you could harvest those gains at a lower rate. And then on the other side of the coin, if you are thinking about taking a big loss towards the end of the year after this law gets passed and we actually know what it’s going to be, well, those losses could be worth more in the future once tax brackets move higher.
Agree with you. I’m going to jump in here again, Andrew. And that is while that is something you will want to be considering and prepared for, early action may be something you suffer from. If you realize gains too early, and the law doesn’t change and it’s only 28% on the high end, just because it’s written now at 39.6 for cap gains over a million bucks, it could be 28%. Which changes the math. “Oh, I could pay 20 if I’m realizing my gains in 2021, versus paying 28% in 2022,” that might not be enough of a difference to actually force you to do that sale.
And also on the loss harvesting side, yes, if you’re in December and you see a position that’s down and you can wait out that loss and carry it into 2022, that would be a benefit to you. If you see a loss in next week, because the market’s down 20%, take it. Don’t sit around, wait until December hoping it lasts till January. It probably might not.
This one kind of goes to, I think we all probably agree on, not letting sort of a tax strategy override what’s potentially a really good investment strategy. And that Patrick, I think, leads into what you were going to say.
Absolutely. Andrew. To me, the planning opportunities here, we’ve been talking about tax here for 15, 20 minutes with you all. And the other sides of this, of course, are the financial planning, the investment management, how is it impacting your estate?
And you really need to be thinking about all of these different lenses because something that really optimizes it for purely one of those things might be to the detriment of others. To me, the number one planning opportunity here is to get prepared and be ready for it, so we have a full understanding of what’s going on, on your investments, on your taxes, on your financial plan, on your estate strategy. That way, regardless of what actually happens in this law, you’ve got a really solid base case.
Absolutely. Yeah. You can’t analyze this for yourself in a vacuum. Pulling one lever is going to affect something else as part of your financial plan. It’s important that you can sort of marry all those things together. And we’re happy to do that for you, as part of our financial planning, tax and investment and estate planning approach. We’ll keep that in mind if you have any questions there.
Well, this was a little bit of a shorter episode, but a great conversation. I know that it’s been on the minds of a lot of clients out there, folks that I’ve been talking to so I’m glad that we could get out some high-quality information. What are some of your biggest takeaways before we leave the conversation?
For me, don’t do anything knee jerk. It’s tempting to see things in the media and say, “Gosh, rates are going up. I need to sell, I need to do this. I need to do that.” The thing that we are counseling everybody to do is think preparation. Let’s prepare for the potential change. Let’s have a plan in case the changes come, so that way we’re able to act quickly. Because it’s entirely possible that this is a tax bill that gets voted on in December, becomes effective right at the beginning of January 2022. And we might have only a few weeks perhaps to implement things. The only way to get that done correctly is if we’ve prepared and planned in advance.
I’m with you 100% on that exact message. Be working with us, be working with your other professionals, know exactly what this tax law and what the potential changes would mean for you. Forecasting the tax expectations for this year in advance. When you have that opportunity, usually around October, November is when we’re focusing on that with our clients. Just go in with your eyes wide open. Do not take any actions today. If you think you’re convinced on exactly what the political mindset is going to be for this law before it takes place, you’re setting yourself up to be way wrong.
Yeah, absolutely. All of that is for sure subject to change. Rick and Patrick, those are two really good takeaways. I’m glad that we were able to do this episode. I do want to just remind the listeners that we will be releasing another podcast episode when this law does actually get passed, and we know what’s going to happen. And you know what, too? We actually just released a blog post titled, “Getting Ready for Higher Taxes,” that covers sort of a lot of the same information. Patrick put that together for us. We’ll link to that in the show notes. That’s another one that you can check out. And we also did a tax related podcast that we released last month. All sorts of things on taxes coming out nowadays, feel free to check all those out.
This has been Andrew Busa, Rick Winters and Patrick Carlson from Adviser Investments, thanking you for listening to the Adviser You Can Talk To Podcast. If you enjoyed this conversation, please subscribe and review our show and you can also check us out at www.adviserinvestments.com/podcasts. Your feedback is always welcome and if you have any questions or topics that you’d like us to explore, please email us at email@example.com. Thanks for listening.
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When we layer these [capital gains and estate] rules together we have the potential for there to be a massive tax increase on those who inherit appreciated stocks.
When we layer these [capital gains and estate] rules together we have the potential for there to be a massive tax increase on those who inherit appreciated stocks.
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