If enacted in its current form, President Biden’s American Families Plan would have a significant impact on taxes – particularly for higher earners. Retirement and wealth strategies expert Matt Sommer details those potential changes and outlines tax planning strategies financial professionals may want to consider implementing with clients should higher taxes become inevitable.
On April 28, 2021, the White House unveiled President Biden’s American Families Plan, which is designed to address a number of issues including more accessible higher education, childcare and paid leave. To help pay for the estimated $1.8 trillion package, the plan calls for higher taxes on the “wealthiest” of Americans. The prospect for higher taxes should not come as a surprise, as the Biden campaign signaled in the summer of 2020 its support for imposing higher rates on individuals with incomes above $400,000.
Last September, as the outcome of the 2020 election was still unknown and many investors were wondering how a change in the White House could impact future tax bills, I outlined Biden’s proposed tax plan in a 60-second primer. At the time, I noted that it may be too early to make changes to existing financial plans in anticipation of possible tax law changes.
The same holds true today. At this point, it is still too early to know if the American Families Plan will pass. Further, it is very possible that the initial proposal may change as the legislative process unfolds.
But I am always a strong proponent of being informed and prepared. I would encourage financial professionals to familiarize themselves with the plan so they can address the inevitable inquiries from clients, while cautioning against taking actions that at this point are premature.
That said, following are the key highlights from the American Families Plan that, if enacted in its current form, would increase taxes three ways:
- The 37% marginal rate would be increased to 39.6%. Although not specified in the official April 28, 2021, Fact Sheet, a White House spokesperson indicated that the rate would apply to single filers with income above $452,700 and joint filers with income above $509,300. It’s important to note that these thresholds would penalize married taxpayers: Two single individuals who each earn $450,000 would escape the highest rate, but $390,700 of a married couple’s combined income would be subject to the 39.6% rate.
- Households with income above $1,000,000 would pay ordinary income taxes, at a presumed rate of 39.6%, rather than today’s more favorable capital gains rates. With the maximum capital gains rate presently at 20%, the proposed plan would effectively double the tax on the sale of appreciated property. No additional information has been released as to whether the $1,000,000 applies to single or married filers.
- Appreciated property left to heirs or other recipients (except charities) in excess of $1,000,000 ($2,000,000 for couples) would no longer be eligible for a step-up in cost basis. Further, although not specified in the Fact Sheet, many observers have suggested that the intent of the American Families Plan is to deem property sold upon death, thus triggering an immediate capital gains tax. Exclusions would be available for family businesses and farms, in addition to a higher allowance for real estate assets.
In my original post on Biden’s tax plan, I outlined some tax planning strategies financial professionals may want to consider implementing with clients in the event that higher taxes become inevitable. I’ll recap those here, again with the caveat that these concepts are nothing new; rather, they are time-tested approaches to managing the tax implications of your investments.
- Consider taking advantage of a Roth 401(k). For investors who already have a substantial amount of assets built up in a pre-tax plan, diverting some of those assets to a Roth will allow the money to grow tax free, helping to provide additional diversification from a tax perspective. Simply put, this strategy gives you more options and greater flexibility – regardless of what happens to tax rates in the future.
- Harvest tax losses to offset capital gains. If tax rates go up, incorporating tax-loss harvesting into your investment plan could be a useful strategy to help minimize your tax liability. If you have investments that have lost value, you can sell them and use the capital loss to offset any capital gains. In 30 days, the same security may be repurchased again. And even if you cannot use all of your losses immediately, you can carry them over indefinitely to offset future gains. (As a reminder, to generate a capital loss, a wash sale must be avoided. A wash sale occurs when a security is sold at a loss and the same or a substantially similar security is bought within 30 calendar days before or after the sale.)
- Focus on tax-efficient investing. The greater the disparity between ordinary income and capital gains, the more important it is to pay attention to the tax treatment of your investments. Asset location – how you distribute your investments across savings vehicles – is just as important as asset allocation. By strategically placing high-tax investments in tax-deferred or tax-exempt accounts, you can potentially lower your overall tax liability.
Of course, as with any tax-related considerations, be sure to consult with your tax advisor or accountant before making any changes.