Before we dive in, I have to point out that we simply can’t predict, with any reliability, what’s going to happen in politics. What’s said on the campaign trail does not always hold much weight when push comes to shove. The policies we discuss here are only theoretical. We may see modified versions of them, or we may not see them at all. Bear that in mind as you proceed.
How quickly will taxes and estate law change under this new administration?
While the emotion and fervor of campaigns and elections might lead us to believe things will change very quickly, that is not usually the case. Candidates tend to overpromise, and we tend to overestimate the speed at which new policies can be put into place.
On a recent webcast, Schwab’s Chief Investment Strategist Liz Ann Sonders suggested that big changes, if they do happen, would likely come in 2022. The focus for the rest of this year would be issues like COVID and infrastructure. Combine that with the fact that these types of changes are rarely retroactive to prior years, and it seems that 2021 may be quieter on the policy front than most expect (at least when it comes to tax and estate law).
Are my personal taxes going to be higher?
It depends. The most common proposal of the Biden administration seems to only apply to those in the highest tax bracket, which could move from 37% back to 39.7%. President Biden has repeatedly said he will only increase taxes on those making over $400,000 of income.
Another area up for debate is Social Security and payroll taxes. Currently, only your first $142,800 of income is subject to that tax, and any earnings above that are not. The Biden proposal would continue to tax up to $142,800, and no tax would be due for earnings between that and $400,000. But for earnings above $400,000, that tax would pick back up, meaning high earners would pay more.
For those of you who would be affected by the above, if it is implemented, it will be even more important to make sure you know what tax breaks are available to you once that happens. Things like contributions to retirement plans, charitable giving, and understanding itemized deductions will become even more valuable. For example, there is some speculation the $10,000 cap on state and local tax deductions could be repealed, meaning higher deductions for many. Also, if you have the ability to recognize more income before these changes (and subsequently less income afterwards at a higher rate) that may be worth considering.
Do I need to worry about changes to the way my estate will be taxed when I’m gone?
The short answer here is yes, but that was already the case before the election. All the changes from the Tax Cuts and Jobs Act of 2017 were already set to expire in 2025. This includes the lifetime exemption for an individual of $11.7 million (or twice that for a couple) that allowed assets under that level to be passed to heirs free of the 40% estate tax. That was due to be roughly cut in half by 2025, possibly back to the $5 million level it was previously. Under President Biden’s plan, there are rumblings that reduction may happen sooner than 2025.
This means individuals with estates between $5M and $11.7M (or couples between $10M and $23.4M) may soon have estate tax issues that they did not have before. If you are in this range, or think you may be in the future, it is worth considering ways to use up your current lifetime exemption while it is larger. Even if it gets lowered, the IRS has said it will not claw back any estate taxes retroactively.
So, if you have a large estate, consider tactics like irrevocable trusts, gifts to family, and charitable giving to maximize the money you leave behind and shield it from Uncle Sam. Of course, it is important to make sure you can afford to do this while still maintaining your desired lifestyle and necessary expenses. Consult with a financial planner to make sure this makes sense.
One other possible change here is the elimination of the step-up in basis at death. Currently, if you die, the gains on your investments get “stepped up” to what they were worth on your date of passing. This allows your heirs to sell the assets without having to deal with massive gains you might have accumulated over the years. If this is no longer allowed, your heirs would be stuck with your low basis and would face significant tax consequences if they wanted to sell the assets.
If that change is enforced, it will be crucial to take a look at which assets you are leaving to your heirs and how it might affect them. It might be very helpful to have your financial planner and estate attorney meet with your heirs. Generational financial planning incorporates the financial and tax situations of your heirs, and enables you to make sure you pass along your assets in the most efficient way possible for everyone involved.
What about taxes on my investments?
There are a couple changes to keep an eye on here. One is capital gains tax rates. Currently, if you hold an investment for more than one year and sell it at a gain, you owe taxes on those gains at a rate between 0-20%. This is much more favorable than if it were taxed as ordinary income.
There have been rumors that President Biden wants to end this favorable treatment of long-term capital gains. This could mean that any investment gain you realized would be taxed at the same rates the rest of your income is, possibly resulting in a much higher tax bill. However, it seems that this change is only proposed for those earning over $1 million in income.
If you are worried about eventually paying ordinary income on your investment gains, consider selling some before any future tax changes and locking in that 0-20% rate. Note that it is still important to consider how this will affect your current taxes. Even if rates go up in the future, it still may be better to wait depending on what your tax situation looks like right now. Talk to an accountant or financial planner to determine if it makes sense for you.
Will my business tax rate increase?
For business owners and entrepreneurs out there, a few possible changes seem to have momentum. This includes a raise of corporate tax rates from 21% to 28%, elimination of the new qualified business income deduction for high earners, and increased payroll taxes for high earners.
Similar to individuals, it will be important for businesses to understand the best ways to shield their income if tax rates go up. And, if possible, recognize more income in the year(s) before the change is enforced. It has also been suggested that these tax increases would come with new tax breaks that may help some businesses offset this change, so it will be important to maximize any new deductions and credits that may apply to your business.
It bears repeating, we’re (thankfully) not in the business of predicting what’s going to happen in Washington, but you don’t have to be in order to make the right decisions. The key is staying on top of the changes and being ready to react. Lean on your financial planner, tax advisor, and estate attorney to keep you informed and make proactive suggestions that can help you in the long run.
Thanks for reading!