Should I be Worried About Potential Tax Increases?
We wrote last week about the potential impact on market valuations as a result of various headwinds making the news every day – Delta, inflation, tax increases – and why it makes more sense to focus your time and energy on those things that you can control.
Specific to tax increases, we’ve been fielding questions/concerns since before the election on how to plan.
My response today is the same as it was back in January or last fall – we won’t know exactly how to plan until, or if, legislation is actually passed. The democratic party majority is still so slim that there is still no guarantee that anything gets passed. There are a few key democratic senators who are not yet on board with the Biden Administration’s $3.5 trillion proposal and there are representatives in swing districts who need to think carefully on how they vote if they expect to keep their jobs beyond 2022.
What we do know is that the Biden Administration’s tax proposals do not impact the vast majority of taxpayers. The plan does not raise taxes on anyone making less than $400,000 a year. The tax rate on capital gains is proposed to increase to 39.5% for taxpayers with Adjusted Gross Income of $1 million or more, which represents about 3/10ths of 1% of all U.S. taxpayers. In other words, it is not expected to impact 99.7% of taxpayers, which is similar to the amount of taxpayers who are not subject to federal estate taxes.
The elimination of the “step-up in basis at death” as proposed retains carve-outs for personal residences ($500k excluded from capital gains per couple), family businesses and farms ($2.5 million per couple). The concern with eliminating the step-up is that some businesses may have to pay taxes on any appreciated value greater than $2.5 million, which could force liquidations of businesses to raise the funds needed to pay any taxes due (and create employee layoffs) where the owner’s net worth is tied up in the business itself. Needless to say, senators and representatives on both sides of the aisle share this concern.
Specific to family farms, no tax is proposed to be due at death as long as the farm stays in the family (i.e., children inherit and own/operate). If the next generation later decides to sell, then the first $2 million per couple is excluded from capital gains ($2.5 million if the farm includes the family home). Estimates indicate that 99.8% of farm estates will not owe any taxes where the farm stays in the family. With that said, more than a dozen Democratic representatives from farm districts remain in favor of retaining the step-up in basis at death given their constituencies.
In the meantime, there are plenty of headlines on the issue of tax increases and there is plenty of marketing going on to support planning for potential tax increases from the financial services industry, the estate planning community and insurance companies. It’s in their interest to leverage the uncertainty.
But for now, the bottom line is that there is nothing extraordinary to do until we know exactly what the new rules are, if any. Given the limited number of taxpayers expected to be impacted, it makes more sense to focus your time and energy on what you enjoy and what you can control.
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