Last month, President Biden unveiled the American Families Plan. As part of the plan, Pres. Biden discussed how he intends to raise the revenue necessary to pay for his proposal. While it is uncertain if the President's plan will pass in its current form, it is well worth reviewing some of the bigger changes that the plan is proposing as well as the possible planning considerations for wealthy individuals and families.

KEY PROPOSED CHANGES

Increased Top Tax Rate

• Restore top Federal tax rate from 37% to 39.6%, presumably for those making over $400,000 annually.
• When combined with CA state taxes, the all-in rate would move well above 50%.

Subject Long-Term Capital Gains and Qualified Dividend to Ordinary Income Tax Rates

• Biden's plan would impact wealthy individuals and families making over $1 million a year by taxing long term capital gains at the top ordinary income tax bracket and would result in a 43.4% federal rate. Those making under $1 million would not see an increase.
• This is in contrast with the current, lower preferential long term capital gain rates that range from 0% to 20%.
• When combined with state taxes, the top tax bracket for capital gains would move above 56%.

Eliminate the Step-Up in Basis

• At present, when you die with appreciated assets, your heirs who inherit those assets are not forced to pay capital gain tax on the previous appreciation. No income taxes are paid at death and the heirs have a much lower tax bill when they eventually sell.
• Under Biden's plan, step-up in basis would still exist but only for gains less than $1 million for an individual, or $2.5 million per couple, when combined with real estate exemptions.
• Estates with taxable gains in excess of $2.5 million would be subject to capital gains tax at death.

Eliminate the Carried Interest Rule

• Income associated with "carried interests" would be taxable at the ordinary income tax rate as opposed to the preferential capital gains rate.

End of 1031 Exchanges for Real Estate

• A 1031 "like kind" exchange transaction is a swap of one real estate business or investment property for another that enables deferral of capital gains taxation.
• The proposal would eliminate that deferral for gains in excess of $500,000.
• The home sale exclusion of $250,000 (single) to $500,000 (married) on the sale of principal residence would stay as it is presently.

WEALTH PLANNING CONSIDERATIONS

Charitable Gifting

• For individuals and families subject to the potential 39.6%+ capital gains bracket, gifting of appreciated securities, either directly to the charitable institution or into a Donor Advised Fund (DAF), provide a multi-pronged benefit.
• From a personal financial perspective, gifts of appreciated stock not only provide a current tax deduction, but the gift provides a second tax benefit by removing future taxation resulting from an eventual sale of those assets or at death if the step-up goes away.
• Furthermore, charitable gifting can be a useful portfolio management tool, especially when managing concentrated stock positions possibly resulting from employee equity compensation (RSU, ISO, NQSO, ESPP).

Focus on Estate Planning to Transfer Wealth Down to Future Generations

• Generally, under the current law, when a decedent passes away, their assets (stocks, bonds, real estate, etc.) receive a "step-up" in income tax basis.
• When the basis is "stepped-up," it has the benefit of reducing, or eliminating, taxation on the subsequent sale of those assets by inheritors. This has provided a significant benefit to inheritors - who are usually the children.
• While estate planning tactics have long involved removing assets from the parents’ estate for purposes of estate tax assessed at death, there will be an additional focus to remove assets from the parents’ estate for purposes of estate tax AND capital gains tax.

Timing Income Events

• For individuals and families whose total income is just under $1 million per year, realizing a large capital gain may tip the scales over the $1 million threshold and cause that gain to be subjected to the higher tax bracket.
• Depending on the asset being sold, it may be advantageous to put together a multi-year plan for the sale of those assets.
• For stocks, ETFs, and mutual funds- this may translate to a plan where assets are sold each year depending on the level of income and available losses for offset.
• For real estate, this may look like an installment sale.

Maximizing Contributions Into Tax Deferred Accounts and Tax Free Accounts

• Maximizing contributions into IRAs, 401ks, and Defined Benefit plans will continue to be beneficial as a means of deferring, or eliminating, tax associated with contributions and their subsequent growth.
• Assets held inside these tax-favored accounts do not generate taxable investment income resulting from dividends or sale of appreciated assets.
• For Traditional IRAs and 401ks, tax occurs when the assets are eventually withdrawn.
• In the case of ROTH IRAs and ROTH 401ks, future withdrawals occur tax-free as long as certain provisions are met. ROTH accounts have the additional benefit of not being subject to RMD withdrawals and can retain their tax free status when passed down to inheritors. This makes ROTH accounts a viable inheritance planning tool.

INVESTMENT MANAGEMENT CONSIDERATIONS

Strategies That Optimize for Tax Loss Harvesting

• For wealthy individuals and families subject to the higher capital gain rate, realized losses may become even more valuable than before.
• Realized losses are able to offset realized gains, no matter the tax bracket, and any unused losses are carried forward into future years where they can offset future realized gains. This has the effect of reducing a current, or future, tax bill associated with the sale of appreciated assets (company stock, sale of real estate, etc.)
• Customized Separately Managed Accounts (SMAs) that implement a disciplined tax loss harvesting strategy can provide an investment return in line with a given benchmark while simultaneously generating taxable losses used to offset gains.

Exchange Traded Funds (ETFs) as Core Building Block

• The structure of an ETF allows it to defer capital gains without needing to make an annual capital gain distribution. This is in contrast to the mutual fund structure that passes through investment income.
• While an ETF only defers capital gain, it has the effect of reducing "tax drag" by eliminating the ongoing tax payment associated with distributions.

Use of Tax Sensitive Active Managers

• For strategies where an active manager is appropriate, like a mutual fund, a continued focus will be placed on managers that strive to be as tax efficient as possible with their strategies.
• Tax efficiency comes from lower turnover strategies, which may reduce capital gain realization, combined with an awareness of loss harvesting inside of the fund.

If you have any questions on the President’s tax changes and how it may affect your family, please reach out.

We hope that you and your family are healthy and staying safe. As always, thank you for your continued trust and confidence.