During his first 100 days in office, President Biden proposed a 3-part plan to bolster the American economy and to provide much-needed relief to families struggling in the wake of the COVID-19 pandemic. With part one, the American Rescue Plan, already in effect, attention now turns to other reforms, including significant restructuring of tax obligations that could affect your return. One plan, in particular, the American Family Plan, includes the potential for substantial tax increases by raising the capital gains tax rate (tax on profits made through the sale of stocks, real estate holdings, and other securities) and the way this tax is calculated.
Changes to the Capital Gains Tax Rate and Stepped-Up Basis
President Biden has proposed increasing the tax rate applied to long-term capital gains from 20% to 39.6% for households with taxable income over $1 million. A long-term capital gain applies to gains derived from assets held for over a year.
President Biden’s planned changes to the tax law could also affect how much of their inheritance your heirs get to keep. Typically, when someone inherits an asset and then decides to sell it in the future, they are obliged to pay taxes only on the gains accrued since the date they acquired the asset—not on how much it has appreciated since its original purchase. It is known as a “stepped-up basis” and proposed changes to the tax law will close this long-standing loophole. Elimination of the stepped-up basis would likely significantly increase the tax obligation of those who inherit large sums. This is a particular concern for individuals inheriting assets of significant value, real estate, and family farms that have been owned by the family for a significant period of time.
Opponents of the Biden plan are concerned that it also creates a “double-dip” situation in which the taxpayer could be taxed twice—once at the time of inheritance and a second time in the form of a capital gains tax on any accrued wealth since the passing of the decedent. A second concern is that the capital gains portion of the tax might have to be paid upon transfer of assets, not after assets have been sold off. This can place inheritors in a sticky situation if they are not able to pay the tax without selling some newly inherited assets.
What About the Estate Tax in the Future?
While not part of the American Family Plan as presented, there is speculation that President Biden and Congress could push for a reduction in the amount of a person’s estate that is exempt from the estate tax. Initially, Biden proposed reducing the estate tax exemption from its current rate of $11.4 million and increasing the maximum estate tax rate.
The estate tax (also nicknamed “the death tax”) has long been a point of contention between lawmakers and tax policy advocates. Defined as a levy on estates whose value exceeds the exclusion limit, the current tax rate is 40%. Biden has suggested that this rate should be increased to 45% along with a reduction in the estate tax exemption.
It’s important to note that an estate tax applies only to assets before they are distributed to beneficiaries and such taxes are paid by the estate. An inheritance tax, however, is applied after assets have been inherited and is paid by the inheritor.
Eleven states and the District of Columbia have their own estate tax laws, with thresholds ranging from $1 million to $5.8 million. These taxes are applied in addition to federal estate taxes. Six other states apply an inheritance tax, so if you live in one of these areas, instead of being taxed before your estate is disbursed, your beneficiaries may also owe the state a cut after they receive their inheritance.
Over the years, taxpayers have exercised a range of discounts, deductions, and loopholes that significantly reduce their estate tax obligation.
How Can You Protect Your Assets and Lower Taxes?
With changes coming to the tax code, you may want to reassess your personal and estate plan. Here are a few strategies you can use to offset the coming changes and protect your assets…
- Tax gain harvesting. Is a process by which you turn unrealized gains into realized gains so that these “new” gains are taxed at a lower tax rate. This tactic is often utilized when tax rates are expected to increase.
- Tax-loss harvesting. Is a process by which unrealized losses are turned into realized losses which subsequently can be used to reduce realized tax gains and ultimately, the total amount of income that is subject to tax
- Invest in life insurance. This lets you draw from your taxed accounts to pay for a universal indexed life insurance policy and thus have your death benefit paid tax-free to your beneficiaries
- Try a Roth IRA. Not all IRAs are the same, and a Roth IRA will allow you and your beneficiaries to make withdrawals tax-free when the time comes.
- Gift your assets now. Another way to reduce your estate tax obligation is to gift assets to your heirs now. As long as you stay below the $15K threshold, you’ll accrue no further tax obligation, and you’ll be able to share your wealth with your loved ones while you are able to watch them enjoy it.
- Consolidate your debt. If you have debts at the time of your death, your creditors can come after your estate, and your heirs. By consolidating your debt now, you can save costly interest payments and have more to leave to your heirs.
- Invest smartly. By continuing to grow your assets now, you’ll be able to leave your heirs in a more secure position when the time comes.
How We Can Help
At Moskowitz LLP, we’ve built our reputation helping clients navigate the often daunting world of tax law. Our experienced tax accountants, tax attorneys, and consultants are standing by to assist you. Why pay more tax than you need? Our skilled and professional staff can explain your options, crunch the numbers, and minimize your federal tax obligation while keeping you in full compliance with the latest changes to the tax code.
Don’t go it alone. Contact us today!