The proposed tax increase will likely impact most wage earners directly or indirectly. Those living off their investments will also be affected. The language in the proposal vs. the offered narrative is not the same. Estate planning attorneys and accountants will certainly have their work cut out for them.
I recently spoke with two CPAs and rather than interpreting the ambiguous parts (there are many), I’ll give some highlights.
The top marginal rate will increase from 37% to 39.6%.
Capital gains will see a large increase for high earners. The current top rate is 23.8%. This will increase to a much as 43.4%. (39.6% top rate plus 3.8% net investment income tax) – OUCH!
The elimination of a stepped-up basis.
Currently, the cost basis of a capital asset is “stepped-up” to the asset’s fair market value on the date of death with no tax consequence to the estate or the inheritor. Property like real estate and securities benefited most from the step-up in basis. Often holders of assets will pass on the investment to heirs or a trust. Under the proposed tax increase, assets bequeathed to another person or trust will be treated as sold. This can present challenges to anyone inheriting assets, as taxes will be due on assets not yet actually sold. Since the asset inherited is considered sold, this could significantly alter someone’s income bracket in the year the asset was inherited. One concern is that someone may receive a one-time inheritance that could put them in a much higher tax bracket. The most significant tax increase will be for individuals with an income of $400,000 and above ($450,000 for joint filers). Since the tax increase has not been passed, we have yet to determine how this will be addressed. If a couple making $75,000 each ($150,000) were to inherit an asset that had a capital gain of say $400,000, would that put them in the higher bracket affecting not only their inheritance but their earned income as well? I doubt a married couple with a combined income of $150,000 would be thrilled with the prospect of potentially finding themselves in a tax bracket north of 39%.
The estate tax will see a big change as well.
The estate exemption currently is $11.7 million. That would change to $3.5 million. Currently, federal taxation is 40% above the exemption amount. Some states have an additional tax on estates. Those thresholds vary by state.
Wealth will be treated as wages for high earners. Currently, realized gains are taxed. Under the proposal, those with incomes of $1,000,000 and above AND assets above $10,000,000 will be taxed based on not only realized gains but net unrealized gains as well. This baffles me a bit (a bunch). Since taxes may be charged on unrealized gains, will additional taxes be paid when those gains are realized? If so, would the tax previously paid adjust the cost basis? They’ll probably cure the common cold before this is sorted out. The potential market volatility this may create is unsettling.
It’s not uncommon for parents/grandparents to transfer stocks to their children/grandchildren. Currently, such a gift maintains the original cost basis and is taxed only when the stock is sold. Under the proposal, the difference between the cost basis and the market value would create a tax liability to the person giving the gift. I assume the cost basis would be adjusted for the person receiving the gift, but I’m not certain of that. Also unclear is how the allowable $15,000 annual gifting would be affected.
Certain trusts used for tax planning would also be impacted.
If and when the tax increase occurs, it will be imperative to have your attorney review these documents.
One question on this proposal is when it might be effective. It COULD be effective at the date of introduction; based on history, that would seem unlikely. However, until recently, I thought many of the components of the tax proposal were also unlikely.
The best suggestion I can offer here is to pay close attention to the proposed tax increase. Don’t assume you won’t be affected. The narrative associated with this proposal will vary significantly from the actual impact. Also, be prepared to use a tax lawyer and or CPA to sort out appropriate actions. The cost of using an expert is far less than waiting until it is too late.
November 2021
The content in this blog is based on an October submission date.
Content in this material is for general information only and not intended to provide specific investment, legal, or tax advice or recommendations for any individual. Consult the appropriate professional prior to making any decision.
