22 September 2021

Key Financial Planning Considerations For Current Tax Reform Proposals

Share This Story

Recently, the Biden Administration introduced the American Families Plan, which, among other things, proposes a series of increases in individual tax rates to pay for a massive new spending measure supporting childcare, paid family leave and education. While the American Families Plan is still a proposal and many specifics are scarce, along with other proposals being floated, the following can be helpful for client estate, tax and financial planning conversations in the meantime.

Elimination Of The Basis Step-up At Death: The step-up in basis would cease for gains above $1 million. This seeks to eliminate a popular estate planning tool where assets are stepped up to the date of death value upon death. The desire to eliminate the step-up in basis is not new. Its elimination has been discussed for the past decade. However, removing it may be more challenging than it seems. The intent of the step-up in basis is grounded in administrative convenience because it is very difficult to determine the basis on assets held for decades, not to mention tracking depreciation and add-backs. As a result, recalibrating the cost basis at someone's death is infinitely easier to determine. For this reason alone, the step-up continues to survive year-over-year and may survive this challenge too.

Capital Gain Realization At Death: A new Senate bill—the Sensible Taxation and Equity Promotion Act (STEP)—would trigger the realization of long-term capital gains on lifetime transfers and at death. There would be an exception for the first $100,000 of gain for lifetime transfers, and at death, there would be an exclusion for the first $1 million of gain. There are also exclusions for farms and closely held businesses.

This may be worse than eliminating the step-up because it would force the realization of gains even if assets are not sold, but merely transferred. This would have a similar effect to the estate tax by triggering tax even if there is no immediate liquidity. If it passes, planning for liquidity for lifetime and death transfers will become a prime planning objective.

Reduction Of Estate And Gift Tax Exemption: The current proposal does not address a change to the estate tax exemption amount, although reducing the exemption was part of Biden's campaign. While this is a significant relief for many, a bill introduced in the Senate—the 99.5% Act—proposes decreasing the gift tax to $1 million and the estate tax to $3.5 million. Again, it's important to note that this could change as the bill works through Congress and it is not law. As a result, at least for now, we can breathe a sigh of relief that the estate tax is not on the chopping block until 2026.

Enactment Date: The American Families Plan is still a proposal. Before we see anything become law, we're likely to see extensive negotiations and a process that could take months to work its way through Congress.

In the meantime, the proposals are silent on an effective date. While tax law changes are typically prospective, there’s significant talk about these changes being retroactive. A revision of the 2021 budget is possible, which means changes to the tax law could go into effect in 2021. Why is this? The Senate parliamentarian determined another revision of the 2021 budget is possible this year. Through reconciliation, this could include implementing both the American Jobs Plan and the American Families Plan through a simple majority vote, rather than requiring sixty votes (similar to how the Tax Cuts and Jobs Act (TCJA) was passed in late 2017).

However, due to the impact on these tax law changes, significant negotiations are likely to occur, even amongst Democrats, which means it could be later in the year or even into early 2022 before we have clarity. Alternatively, the changes could be passed in an end-of-year budget bill—reminiscent of the SECURE Act in December 2019.

Planning For Uncertainty 

These proposed changes are significant, and clients and their advisors should not be complacent if they have a scenario where acting today is advantageous. Reviewing options today will help them be prepared to act when a law is actually passed.

Increase In Capital Gains: 

1. Harvesting Gains: Capital gains today are the lowest they have ever been. Therefore, if capital gains rates are set to increase, it may be best to sell some winners to lock in a lower tax rate today. In the right circumstance, this could result in a lower tax bill and the opportunity to rebalance a portfolio into more tax-efficient investments.

2. Tax-loss harvesting: Since the proposed higher tax rates are for those with income over $1 million, initiating plans to keep income below $1 million will be key. Therefore, it would be advantageous to strategically capture losses to offset future gains, especially if they can keep net income below the magic $1 million threshold.

3. Charitable Giving: Similar to tax-loss harvesting, strategically giving to charity would help drive down net income, which could help keep clients out of the top marginal bracket and prevent the realization of gains in this top bracket too.

4. Capital Gains Bunching: Like bunching for charitable giving, this involves strategically selling assets so that total net gain realized is close to but below a $1 million tax threshold. By doing this, a client would not trigger a higher 39.6% tax rate. This strategy could be facilitated year-over-year to minimize taxes.

5. Hold assets longer: The tax code is constantly evolving. Those who do not intend to realize any significant gains in the coming years could wait to see what happens under a future administration. Just as the current administration desires to implement these tax changes and unwind the TCJA, we could see the same happen for the American Families Plan under a future administration. Of course, this is a big unknown, but deferring the realization of gains may be at least a partial strategy worth considering if it works out for a client's situation.

Changes To The Step-Up And Realization Of Capital Gains At Death 

If the step-up is eliminated, gifting assets during life becomes much more appealing because it removes future growth from a client’s estate. The best options are those that create flexibility and liquidity, which include the following:

• Grantor trusts allowing for post-execution planning—such as swapping assets, borrowing, and loaning.

• Irrevocable trusts that create flexibility for gifting to a charity

• Spousal lifetime access trusts allowing spouses to irrevocably gift assets to each other, which uses the temporarily high gift tax exemption amounts today while also giving each spouse indirect access to the assets through their spouse.

• Life insurance held in an irrevocable trust creates liquidity for paying taxes and is income tax-free at death, while also remaining outside an estate for tax purposes.

• Gifting low-basis assets to charity or within a charitable remainder trust (CRT) allowing for removal from the estate and creating a tax deduction (can be used to diversify from concentrated positions). The CRT also creates an income stream for life or up to 20-years.

• Valuation discounts that leverage gifting above the estate tax exemption amount.

While none of the above strategies is a silver bullet by itself, using them in some combination could result in benefits for clients. Ultimately, none of the proposals are law and any that become law will undoubtably look different in their final form. As a result, no strategy should be implemented without significant discussion and planning. However, planning ahead will be critical because all of the above strategies take time to design and implement. As noted, we could see these proposed tax law changes implemented in an end-of-year budget plan, which would leave little time to implement strategies from scratch.

Click here for the original article.


Join Our Online Community
Join the Better Way To Retire community and get access to applications, relevant research, groups and blogs. Let us help you Retire Better™
FamilyWealth Social News
Follow Us