Advisor Q&A: Tax Planning and the American Families Plan with Senior Advisor Chris Wheaton

May 13, 2021

President Joe Biden recently released an outline of the American Families Plan (the Plan), which follows many of the provisions that Biden outlined in his campaign. We asked Litman Gregory Senior Advisor, and former practicing CPA, Chris Wheaton a few questions about the Plan to better understand how it may impact planning with clients.

Chris, before we get into the details of the Plan, can you first explain whether these proposals are set or if we should expect changes as they progress through Congress?

Yes, it is important to point out that there will be changes to these provisions as they move through the legislative process. The Plan contains numerous large tax increases, so it is unlikely to garner support from any of the 50 Republican senators. Therefore, the Plan would need all 50 Democrat or Democrat-leaning Independents to vote in favor of it to become law. As has been the case with other legislation, more moderate senators could ask for changes to the law, which might result in eliminating certain provisions, adding others, and/or lowering the proposed rates. So, while it is wise to start thinking about steps to take to minimize tax liabilities, we think it is best to wait to see what the final legislation looks like before implementing planning moves.

Could you provide a quick review of the key provisions of the Plan based on the Fact Sheet released by the Biden administration in advance of his speech on April 28, 2021?

Here is a summary of what we see as the key provisions of the Plan and their potential impact:

  • Increase the top individual income tax rate to 39.6% for taxpayers “within the top one percent.” The Plan does not cite specific income thresholds that would apply for individual and married filing jointly taxpayers, but past discussions referenced a level of income of $400,000 or greater.
  • Tax income from long-term capital gains and certain dividends at ordinary income rates for “households making over $1 million.” The Fact Sheet does not specify if the threshold would apply to taxable ordinary income or investment income (or both). If coupled with an increase in the top marginal tax rate, this could increase the federal tax rate on long-term capital gains for households with income above $1 million from 23.8% to 43.4%. (As an example, for residents of California the top state tax rate is currently 13.3%, so their top combined federal and state tax rate could be as high as 56.7%.)
  • Repeal the step-up in cost basis of inherited assets at death for unrealized capital gains greater than $1 million. Special rules (not described on the Fact Sheet) would apply to protect family-owned businesses and farms that are passed on to “heirs who continue to run the business.”
  • Permanently eliminate the “carried interest loophole,” which is a provision where certain profit-based income earned by hedge fund general partners is taxed at favorable long-term capital gain tax rates vs. higher ordinary income tax rates.
  • Presumably end the Section 1031 like-kind exchange rules for deferring the realization of capital gains on real property greater than $500,000. Under current rules, unlimited capital gains on the sale of certain real estate can be rolled over into a new property (or, in other words, the cost basis of the old property is carried forward) if certain rules are followed.

Chris, were there any tax provisions that have been in discussion that you were surprised to NOT see mentioned in the Plan?

Yes, the most surprising omission was a change to the estate/gift tax exemption, which is currently $11.7 million per person. Many had expected to see proposals to lower this amount to $5 million or less per person. We will continue to track potential changes in estate tax laws, as this is a key area of wealth planning that we focus on with clients.

Given that these proposals may change before they potentially become law, what do you expect could be the effective date of new provisions of the legislation, and how do you suggest people plan for these changes?

The Fact Sheet does not mention the effective date of the legislation, but many Congressional analysts believe that the legislation would be more likely to pass if the effective date is deferred to January 1, 2022. However, there is no guaranty that the effective date will not be in 2021. Based on past tax legislation, effective dates can be retroactive to January 1 of the current year, or when there is committee action on the bill, or made effective on the enactment date.

In terms of what our clients could consider doing today in anticipation of the potential changes, that is hard to say specifically at this time. While it is difficult to determine what provisions will make it into the final legislation, what seems clear is the desire to raise taxes on high-income taxpayers. If legislation passes that increases tax rates in 2022, the following are some tax minimization strategies we will be discussing with our clients:

  • For clients with income that may be over $1 million in 2021 or 2022, and who are considering the sale of a home or business with large built-in taxable gains, we may look at ways they could recognize those capital gains within 2021 when capital gain tax rates may still be lower.
  • The same could be true for clients who could recognize built-in portfolio gains now on investments we may have been planning to sell in 2022 or 2023. Because selling investments at gains does not trigger a wait period for repurchase like selling those at losses*, we could immediately repurchase those investments if desired. (*Under the “Wash Sale” rule, an investment sale resulting in taxable capital loss requires waiting 31 days before repurchasing the same investment, or the tax loss will be disallowed.)
  • For clients considering a like-kind Section 1031 exchange of real estate, with an unrealized capital gain tax deferral of more than $500,000, we may encourage them to execute the exchange before a cap is put in place.
  • In general, we are preparing to help our clients consider accelerating income into 2021. Examples include:
    • If possible, accelerating 2022 bonus income into 2021
    • Accelerating 2022 business income into 2021
  • We may also encourage clients to defer itemized and ordinary income deductions into 2022, when those deductions may have a higher tax deduction value. Examples include:
    • Charitable donations
    • State income tax payments
    • Property tax payments
    • Business expenses

Thank you, Chris, for this helpful review and the summary of some tax planning ideas. As the legislation continues along the review process, how would you suggest that clients keep abreast of changes and additional planning opportunities?

I would suggest that clients be in touch with their Litman Gregory advisors as well as their tax professionals, knowing that we are all watching this tax legislation closely and can continue to provide updates and planning suggestions. We are happy to talk through these planning ideas with our clients, especially given that each person or family’s situation is different and needs a customized approach. As always, we recommend consulting a tax advisor before making any tax planning moves.