The Biden Administration has proposed significant tax increases in various arenas in order to fund the American Families Plan. One of the strongest proposed tax increases affect capital gains taxes, which are taxes assessed on financial assets sold at a profit. Capital gains includes profit gained from stocks, but also includes real estate and business gains. To prepare for the best outcomes with your portfolios in 2021, there are three main areas to think about.

Aimed at Incomes Over $1 Million

Along with raising top marginal income tax rates from 37% to 39.6%, those $1 million+ earners would have the same increase from the current 20% to 39.6% on capital gains. After Net Investment Income Tax is added, including the Affordable Care Act additional 3.8%, capital gains tax could be as much as 43.4%, effectively doubling the current rate. Though the plan was released on May 28th, the proposal stipulates that these changes go retroactive to April 2021 to prevent people from selling off assets prior to the enactment.

Step-Up Basis for Inheritance in Jeopardy – Additional Risk for Estate Planning

Currently, heirs can protect their inheritance by reducing capital gains taxes by taking advantage of the IRS tax provision of Stepped-Up Cost Basis. In a nutshell, it’s considered a legal loophole, allowing investments to have reset value via sale or appraisal of inherited assets to be valued at the time of the original owner’s death. Thus, the current value of an asset when sold or appraised soon after would likely not change much, and therefore would not require a capital gains tax. Biden’s tax proposal eliminates this loophole and could completely change the nature and effectiveness of current estate plans.

Can Affect All Americans – Not Just Millionaires

There are a couple ways that the change in capital gains can even affect Americans who earn well below the $1 Million cap.

• 401Ks – Most middle-class families have a 401K or other retirement investments. These changes in capital gains taxes could trigger a stock and general investment selloff that could, in turn, significantly affect retirement portfolios.
• Small Businesses – If the business is tied in with an owner’s personal income, such as with solopreneurs, the sale of a business could result in an individual’s income raising over $1 million, triggering the new capital gains tax rates.
• Inheritance – Even modest estates can easily add up to $1 million if passing a business or business-related assets and investments are part of the inheritance.
• Selling a home – Home sales have been skyrocketing in recent times, after a huge down market. This means that even with the primary residence exemption rule, (living in the residence 2 of 5 years prior to the sale) a home’s sale could push the owner’s income over the threshold.

Managing the Changes to Protect Your Investments

There are ways to protect your investments and try to avoid the new tax increases. The goal is to reduce one’s income to below the $1 million threshold by donating assets, adding to trust funds, using installment plans to regulate income, transferring funds to tax-efficient assets and using strategic tax deferments.

Jorns & Associates stays on top of tax laws and financial trends so our clients can make informed decisions about their investment plans in real-time with current events.