Now that tax season is wrapping up, we can all take a deep breath. With the pandemic looming over all of us in 2020, change has become the only thing we can consistently count on these days.
COVID aside, there have also been large changes as a result of who is now in the White House, including a shift in tax laws. After a little more than 100 days in office, here are some things you should be aware of when it comes to the Biden administration’s tax policies and proposals.
Capital Gains Taxes
A capital gains tax is a tax on the growth in value of investments (or profit made) when these assets are sold. When an individual cashes out on these assets or investments, the capital gains are “realized,” and these gains are taxed as ordinary income. Long-term capital gains are taxed at a graduated tax rate depending on an individual’s income bracket (the rate ranges from 0%, 15%, and 20%). For individuals who earn more than $1 million in annual income, long-term gains are taxed at a rate of 20%, but this could change. Under the Biden administration’s proposed bill, the “American Families Plan,” both short-term and long-term capital gains would be taxed at a rate of 39.6% for those who earn more than $1 million per year. For high-income taxpayers, there would also be a net investment income surtax of 3.8%, thus making their total federal income tax rate on capital gains 43.4%. The Biden administration estimates that the increased tax rate on capital gains will affect approximately 500,000 households, a relatively small percentage nationwide. (Note that at the time this blog was written, the “American Families Plan” had not been passed by Congress).
In this bill, the Biden administration proposed a tax benefit on appreciated assets, currently known as the stepped-up basis rule for inherited property, be eliminated. The “step-up in basis” allows for inherited property to be sold or liquidated shortly after the death of an individual with little or no capital gains tax. According to IRS Code, Section 1014, the basis of an inherited asset is stepped-up to the “fair market value of the property at the date of the descendant’s death.” This rule applies to any property that has appreciated in value and was held until the owner dies.
What the Biden administration aims to do is eliminate the step-up basis rule. This means that at the time of the owner’s death, the estate would need to come up with the funds to pay for the property’s capital gains. If the estate could not afford to pay this tax (i.e., family members inheriting the property could not pay the tax), they would be forced to sell the property. The proposed bill does, however, include an exemption of $1 million for individuals and $2 million for married couples.
If the American Families Plan is passed in Congress, these new policies would go into effect in 2022.
Today, the law under IRS Code Section 1031 allows for like-kind exchanges for real estate investors as a way of deferring capital gains taxes when selling properties. Like-kind exchanges allow taxpayers to exchange property used for business or held as an investment property with another property of the same type, or a property of “like-kind.” Under Section 1031, investors must direct the proceeds into new investments several months after the sale. The Biden administration’s tax plan would eliminate like-kind exchanges for investors with annual incomes of more than $400,000.
Estate and Gift Tax Exemptions
President Biden has expressed his support for legislation that would reduce the federal estate tax exemption to $3.5 million and would reduce the federal gift tax exemption to $1 million. For properties exceeding the value of $3.5 million, Biden supports an increase on the federal gift and estate tax rate to 45%. This is a progressive tax and would increase the rate to 50% for properties valued at over $10 million and 65% for properties valued at over $1 billion.
Now you may be asking yourself, who is predominantly affected by the Biden administration’s tax plan? Tax rates would not increase for individuals who earn an annual income of $400,000 or less. The tax plan will, however, increase the tax rates for individual taxpayers and corporations who make more than $400,000 annually.
Strategies That Can Help You Prepare
Our estate planning group at Lowthorp Richards deploy cutting-edge knowledge and experience to help your family with solutions to navigate the shifting tax landscape. Strategies include moving assets out of your taxable estate, freezing capital gains tax exposure, and shifting interests to defer or avoid taxes altogether. We welcome the opportunity to help you develop a customized plan for you and your loved ones.