A Potential Playbook to Address Biden’s Proposed Tax Plan

We’ve fielded questions from clients, friends and the press about how to prepare for President Biden’s tax proposals ever since last year’s election. Uncertainty about who will be impacted, and to what extent, has created confusion and angst among many investors. While additional detail was provided when Biden introduced his $1.8 trillion American Families Plan (AFP) in April, we won’t know the specifics of any new tax changes until a divisive Congress acts. Probabilities are high that the details will change as individual legislators negotiate to address their constituents and party ideology.

Rather than overreacting with inflexible and complicated structures to limit the tax impact, recall that tax climates are fluid and change as Congressional and presidential leadership turns over. Any new tax laws may be adjusted with the next administration, whether that be in four years, eight years, or more.

We encourage you to direct your focus to financial planning opportunities instead of the individual provisions that may or may not make it into law.

Increasing Capital Gains Tax with Annual Income Over $1 million

For those whose annual income exceeds $1 million, Biden proposes to nearly double your capital gains tax rate from 23.8% to 43.4%. (note, the proposal calls for this to only impact those with incomes that exceed $1 million, though additional clarification is needed to determine if this is based on the individual or the return. I.e., is it $1 million for a couple or $2 million?)

• Bring forward in 2021 (to the extent possible) gains you anticipate realizing in 2022. This includes shares of Tesla you wisely acquired in 2019 and the sale of businesses or properties. Anything that might cause your Adjusted Gross Income (AGI) to trip the $1 million threshold in 2022 should be fair game.
• Complete charitable giving with appreciated assets. This effective planning technique will become more important to those who see their capital gains rate effectively double. Rather than writing checks to cover your annual tithe, ongoing support of your alma mater, or local and global philanthropic passions, use stocks that have grown substantially in value. This will allow you to avoid ever realizing the gain and potentially reset the cost basis if you use cash to repurchase the security. This includes direct gifts to specific charities and the funding of Donor Advised Funds or Private Foundations.
• Revisit dedicated tax loss harvesting strategies to offset gains elsewhere. Balentine seeks to accomplish this in two ways. For the past 2.5 years we’ve constructed portfolios of broadly diversified individual stocks tailored to specific benchmarks and automatically realized losses within the individual positions to improve after-tax results. [GC1] While the S&P 500 Index returned 18.4% in 2020, 190 of the stocks in the index lost money and eight stocks dropped more than 45%. This provided many opportunities to realize losses, yet enjoy the overall growth of the benchmark. Additionally, Balentine will take advantage of situational harvesting opportunities when markets drop sharply, like March 2020 or December 2018, to sell positions suddenly at a loss, and rotate the proceeds immediately into similar, yet slightly different ETFs.
• Maintain close coordination with CPAs to understand where one stands in relation to the AGI threshold. If nearing it, limiting income to avoid breaching it will be critical. This can be accomplished by realizing losses elsewhere or incorporating Qualified Charitable Distributions (QCDs) to offset Required Minimum Distributions (RMDs) from retirement funds.
• Gift highly appreciated assets as part of any annual giving strategy to family and friends rather than cash if their incomes place them at lower tax rates (15% or 0%).
• Recognize the value asset location and structure has on minimizing your potential tax bill. It will be important to evaluate the pros and cons of maintaining low turnover investments in your taxable accounts and assets with potentially higher turnover in your retirement accounts. ETFs remain attractive vehicles when compared to active mutual funds as individual investors control when to realize gains within ETFs, while active mutual funds distribute capital gains annually.

Decreased Estate Tax Exemption

For those who will likely have a taxable estate at death, the estate tax exemption will drop in half, adjusted for inflation, on January 1, 2026 based on current tax law, regardless of any action by Congress in 2021. Biden’s administration has discussed dropping this further to $3.5 million for estates and $1 million for gifts, and raising the estate tax to 45%, though it has not set forth any formal proposal.

• Complete any major estate planning now. We’ve pounded the table on this for some time because the end to the expansion of the estate tax exemption has been known ever since the law which created it was signed. If you have a desire to maximize what your children receive at your death, or even have a specific amount you wish to leave them that exceeds $3 to $6 million, you should be communicating that to your advisory team as soon as possible. Estate attorneys will have a busy second half of this year.
• Develop an annual giving plan. Present tax law allows each person to give up to $15,000 to anyone, with no limit on the number of individuals. Imagine a couple who wished to gift money to their children, their children’s spouses, and their grandchildren. Each parent could contribute $15,000 to each child, spouse, and grandchild. With three married children and six total grandchildren, they could transfer $360,000 annually with no gift tax implications. As noted above, using appreciated stock to complete this gift may be an effective way to avoid paying Uncle Sam 43.4% of any gains if your AGI exceeds $1 million. Note, Biden’s administration has floated the idea of limiting the total amount of annual gifts which would impact this strategy.
• Don’t forget “Meds and Eds.” You are not limited by the amount of any gifts made to cover medical or educational bills, even for those outside your family. Remember to pay the medical provider or school directly.

Ending Step-Up in Cost Basis for Appreciated Assets at Death

For anyone holding appreciated assets at death, Biden proposes ending the ‘step-up’ in cost basis. Current tax law treats the cost basis of an inherited investment as the market value of the investment on the date of death, rather than the recently-deceased’s original cost. Thus, the cost basis is “stepped up” from the original cost to the current price. For example, your parents may have purchased Coke stock for $1 a share (the original cost basis). In the time since they purchased it, the price of Coke stock has risen to $100 a share where it traded the date of their death (the stepped up cost basis). Under current law, you are only taxed on any future gain above the $100 stepped up basis when you ultimately sell it. Biden’s proposal seeks to end this stepped-up approach and could accomplish this in one of two ways. An heir may retain the original cost basis and pay tax on the larger gain when the asset is ultimately sold, or the estate could treat death like a sale, and pay a tax on any accumulated, yet unrealized, gains. Using the example above, Biden’s proposal includes the $99 growth since original purchase when determining how much capital gains tax is due.

• Use appreciated securities in giving, both to individuals and charities, during life.
• Spend more from taxable accounts and delay/limit spending from retirement accounts to provide your heirs flexibility to stretch out the tax bill rather than paying in one lump sum.

Ultimately, it is too soon to know what changes are in store for all of us, however, it is critical to understand potential implications and begin to develop a plan for how to react. Please reach out to your Balentine Relationship Manager to address your specific situation.