In 2020, we learned how quickly life can change, and there was no way to prepare for the incredible events ahead. The unpredictable year is not over, and we now have an election looming in the coming weeks. However, unlike the pandemic, we can collect information to make informed choices and to better prepare for the scenarios of life under either potential administration. One of which is our financial futures. It is essential to understand the platforms and proposed policies of both candidates to be proactive in your financial planning.
In 2017, President Trump, with the support of the Senate, passed the Tax Cuts and Jobs Act (TCJA). The legislation created substantial tax reforms for both businesses and individuals. Businesses were granted a considerable decrease in corporate income taxes as rates decreased from 35 to 21 percent. Individuals in the highest marginal income tax bracket saw a reduction from 39.6 to 37 percent. Also, those with substantial estates saw a doubling of the lifetime gift and estate tax exclusion amount from $5.79 million to $11.58 million until 2026. These changes provided many tax breaks for higher earners and permitted a greater amount of wealth transfers to be shielded from gift and estate taxes. Americans have experienced the effects of the TCJA for three years under the Trump Administration. It is important to understand potential changes to these policies should there be a change in leadership.
Vice President Joe Biden’s proposed tax plan includes policies similar to those under Barack Obama’s administration. These may involve amending or repealing significant provisions in the TCJA. In the following article, we summarize four of the key changes that may be relevant to your own financial plan.
Increasing long-term capital gains and qualified dividends tax rates to ordinary income tax rates for taxpayers with annual income exceeding $1 million.
The current tax rates for long-term capital gains and qualified dividends for these taxpayers is 20 percent. This allows individuals holding highly appreciated property and meeting the one-year holding period requirements to pay significantly less in gains upon sale. It also provides a substantial tax break for individuals with portfolio income largely comprised of qualified dividends. The Biden plan increases these to ordinary income tax rates by nearly double (to 39.6 percent). Therefore, planning strategies such as selling or gifting highly appreciated assets and reallocating a heavily concentrated dividend income portfolio may be worth considering.
Elimination of section 1031 exchange provisions for those with annual income exceeding $400,000.
Business real estate owners wanting to sell a one income-producing property and immediately purchase second commonly utilize a 1031 exchange. This allows the real estate holder to defer capital gains when reinvesting the sale proceeds into a like-kind qualifying property of equal or greater value. However, for those with annual income exceeding $400,000, capital gains taxes would no longer be eligible for this deferral. The sale would immediately be subject to capital gains taxes.
Elimination of the step-up in basis rules concerning inherited assets, regardless of income.
The step-up in basis rule changes the owner’s basis in property to fair market value at the decedent’s date of death. It is designed to protect beneficiaries of inherited assets from paying substantial capital gains taxes upon transfer. It provides the most significant benefit for those who inherit highly appreciated assets. Eliminating this rule may subject the beneficiary to those taxes upon inheritance, even if they elect not to sell. The result could prove devastating for surviving beneficiaries who are forced to sell cherished valuable property to pay the decedent’s estate taxes.
A 50 percent reduction in the lifetime exclusion amount for federal gift and estate taxes to pre TCJA levels of $5.79 million.
Individuals with estate assets exceeding $5.79 million would be subject to a federal estate tax liability. Depending upon the amount, these assets can be taxed at levels as high as 40 percent. This creates potential issues for beneficiaries of decedents with highly illiquid estates, such as a closely held family businesses valued higher than $5.79 million. Therefore, proper planning is of utmost importance to optimize generational wealth transfers.
At Shepherd Financial Partners, we proactively analyze current events and how they may impact our clients at every stage of the financial life cycle. Regardless of one’s political affiliation, such changes to the tax code could materially affect an existing financial plan. Therefore, it is more important than ever to consider additional planning strategies. We are here to help serve as your trusted advisor every step of the way.
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