Indications are that Joe Biden will be our next president. Clients are asking me what a new administration will mean for their investing strategy should it bring new tax law with it.
They are asking questions such as:
- Should I recognize long-term capital gains now?
- Should I create an irrevocable trust?
- Should I do more Roth conversions?
The probability that Republicans retain the Senate makes it unlikely all will become law, but politics is perhaps the only thing less predictable than the stock market. So, here’s what I’m telling clients:
Understand What’s On The Line
First, I clear up some misconceptions and refer them to the Tax Foundation’s Summary of the Biden Tax Plan. The parts that relate most to investing are:
- Elimination of the step-up basis. No longer can one pass on unrealized gains tax free to their heirs.
- Taxing long-term gains and qualified dividends at ordinary income levels to those with over $1 million in income.
- Phases out the qualified business income deduction (Section 199A) for filers with taxable income above $400,000.
- Expands the estate and gift tax by restoring the rate and exemption to 2009 levels. Those amounts are $3.5 million for single filers, and $7 million for joint filers and are not indexed to inflation.
The vast majority of these proposed changes will have little impact on the mass affluent, but would impact the very wealthy if it became law.
Implications For Taxable Accounts
The one exception that can impact the mass affluent is the elimination of the step-up basis. Mike Piper, a CPA and blogger at the Oblivious Investor, told me this is just one more tax law change that could make investing in taxable accounts less attractive.
It would also further reduce the advantage of locating assets such as stocks with greater growth potential in taxable accounts and bonds in tax-deferred accounts because the step-up basis was one key reason to have stocks in the taxable account.
But there is still an advantage: Stocks are far more likely to have gains than bonds, and the lower long-term capital gains rate for most people is still attractive. This is especially important for those who can “tax-gain” harvest at the 0% rate.
|Taxable Accounts||Tax-Deferred Accounts|
|Broad stock index funds||Taxable bonds|
|Low-turnover stock funds||REITs|
|High-turnover stock funds|
|Fun gambling stock accounts|
The elimination of the step-up basis also makes it even more beneficial to make charitable donations with highly appreciated securities. Finally, it makes Roth accounts and HSAs invested like Roth accounts more advantageous.
Long-Term Gains % Taxes
For the very wealthy and high income earners, however, there are greater impacts.
Not only do they have to try to keep to the 15% long-term capital gains rate (income of $441,450 single and $496,600 joint), they would then need to plan to keep from the 39.6% proposed ordinary income tax rate for those long-term gains.
Thus, recognizing these gains annually to manage tax brackets becomes even more important. Many with huge unrealized long-term gains might recognize large gains this year. This, of course, could backfire if the step-up basis and current long-term capital gains rates stay.
The lowering of the estate tax exemption would make irrevocable trusts more attractive. One of the biggest downsides of these trusts is that the heirs lose the step-up basis, though this would no longer be a downside if this step-up is eliminated anyway.
It would also make annual gifting up to the $15,000 annual gift exclusion more important. Other strategies to pay taxes sooner such as Roth conversions could also be even more beneficial.
Words Of Warning
Remember that there are many things we don’t know.
- We don’t know which, if any, of these proposed changes will become law.
- We don’t know what tax law changes will be in future administrations.
- We don’t know our income in future years or our net worth when we pass away.
Tax planning based on proposed changes can be hazardous to one’s wealth. I agree with Mike Piper that tax planning has always needed to be done on an individual level based on those individuals’ specific sets of circumstances. Piper also notes that, for the vast majority of people, the best course of action is to do nothing at this time.
But stay tuned. The rules are always changing. The goal is to design a tax plan with two things in mind:
- Maximize the tax-efficiency.
- Keep things flexible for future law changes.
Admittedly, doing both is far easier said than done.
Allan Roth is the founder of Wealth Logic LLC, an hourly based financial planning firm. He is required by law to note that his columns are not meant as specific investment advice. Roth also writes for the Wall Street Journal, AARP and Financial Planning magazine. You can reach him at [email protected], or follow him on Twitter at Allan Roth (@Dull_Investing) · Twitter.