How to Prepare for the Possible Upcoming Federal Tax Changes

Federal tax increases are likely coming to the wealthy within the next year. If you have or are projecting significant income or assets, these changes could be impactful on your future finances. Below is a high level view of some of the proposed changes and some general ideas about what you can do to preserve your wealth. However, these taxes are a long way off from reality and will face significant headwinds. And, even if they are implemented, have no guarantee of remaining in the tax code for very long.

Income Tax

President Biden has proposed raising the highest marginal tax rate from 37% to 39.6% and also lowering the income band that is subject to this rate. Currently people paying 37% are earning $518,000 or more (singles) or $622,000 or more (couples). The proposed 39.6% rate would start with people earning $400,000 or more a year. These changes are a return to Obama era rates and income bands.

What to do to prepare for income tax changes:

If you want to avoid paying income tax, you need to lower your income. So, if possible, you could try to

• Collect future bonuses or other payments this year.
• Convert funds to a Roth account. (Learn more about Roth conversions.)

Capital Gains

You pay long-term capital gains when you sell an asset — investments, homes, businesses, and others — that has grown in value over the span of at least one year. You pay capital gains on the growth (gains) of the asset. Biden has proposed almost doubling the capital gains rate from 20% to 39.6%. He would also add a 3.8% surcharge to help fund the Affordable Care Act.

What to do to prepare for higher capital gains taxes:

Here are a few tactics to consider if you wish to avoid paying the proposed higher capital gains taxes: If you are planning to downsize your home or sell a business in the near future, you might want to accelerate your plans. However, if your sell-off plans are a bit farther off, you’ll want to do the math and compare your options. The decision to sell an asset now to avoid higher capital gains taxes requires comparisons and making guesstimates about the projected growth of the asset.

• Start by figuring out when you will want or need the money that would be subject to capital gains. For the sake of example, let’s say you will need the money in 15 years.
• Next, calculate what the asset would be worth if you sell now — subtract capital gains. If you won’t be spending the money, determine how you would reinvest the funds and the possible rate of return and project what the value would be in 15 years.
• Now determine the value of staying invested as you are now. (To do this, apply a reasonable rate of return for the next 15 years. Calculate the continued growth of the money — minus the higher capital gains rate.)
• Compare the values, both current and projected.

Estate and gift tax

While not included in President Biden’s proposal, most experts believe that there will be changes to estate and gift taxes. Currently, people pay estate and gift taxes only if the value is over $11.7 million per person (indexed to inflation) at a rate of 40%. It is possible that the threshold for needing to pay estate and gift taxes will go lower and the rate may go higher.

Other changes

There are some additional proposed tax changes that involve closing loopholes. One of these changes is specifically relevant to people in retirement who hope to receive or leave behind an inheritance.

Elimination of the step-up in basis allowed for inherited property

Currently, if you inherit an asset, your basis is the “step-up” value of the asset — the current value of the asset. So, if your parents bought a home 30 years ago for $150,000 and you inherited it this year at a value of $1 million, and you choose to sell the home immediately for $1 million, then you will pay zero capital gains because your “basis” is the same as the sales price. You have zero gains, so you don’t pay capital gains tax. There are proposals that would nullify the “step-up” in basis. So, heirs might be subject to capital gains taxes on all of the gains seen on the asset. However, there are a lot of details to be worked out, including income thresholds, spousal considerations, and more.

Tax Planning and Your Retirement

The Boldin Retirement Planner enables you to see your potential tax burden in all future years and get ideas for minimizing this expense. It takes forethought, but Roth conversions, taxable income shifts, and other strategies can result in significant lifetime savings. We continue to make enhancements to our tax functionality. Let us know what changes you would most like to see, join our Facebook community, and vote in our tax poll.