For at least a year now, well before the election, there’s been plenty of news, opinions, and frankly bluster about President Biden’s federal tax proposals to fund infrastructure and new social programs including education, nutrition, and childcare. While what is on the table would certainly represent a significant change, especially for U.S. companies and high earning individuals, it is important to keep in mind that these are proposals and we don’t know which (if any) will make it through the gauntlet of Congress. And for any that do, final legislation typically looks a whole lot different than what’s initially proposed.
So while it may be tempting to make decisions now in anticipation of the proposals, each decision requires thoughtful analysis of your specific situation and again points to the importance of a long-term financial plan. It may be premature to make decisions based on mere proposals, but it’s important to be aware of some of the key proposals (in their current form) and consider how they may impact you and your long-term goals, should they be written into law.
In the hopes of bringing clarity, which in turn breeds increased confidence, we’ll quickly summarize the federal tax proposals on the table that we believe are worth tracking. And we’ll clearly separate these proposals, which are still subject to change, from a couple of Washington state-specific tax changes that are already baked in the cake.
Key Federal Tax Proposals
- Increased corporate tax rates. The Biden administration has proposed a U.S. Corporate income tax rate increase from 21% currently to 28%. For Washington-based companies (with no state corporate tax), 28% would the maximum. However, combining this with an average state corporate income tax between 7% and 9%, the combined corporate tax rate would increase to 35% or higher for some American companies.
- Increased individual tax rate for high earners. The top marginal income tax rate would return to 39.6% for taxable income over $509,300 for married filing jointly and $452,700 for single filers according to Biden’s proposal in 2022. Biden has repeatedly said that he won’t raise income tax on anyone making less than $400,000 a year, though there is a lack of clarity on whether that applies to individuals or married couples (a married couple each making $275,000 a year would collectively see their tax bill increase to 39.6% under this proposal even with making less than $400,000 individually). This could open the door to more individualized tax planning with CPA’s including bunching and/or searching for more deductions, increased usage of Roth accounts and conversions, or for those who have the ability to determine when they collect income to spread this out over a few years.
- Removal of federal long-term capital gains rate for highest earners. Under the current law, the top long-term capital gains tax rate is 20% (23.8% with net investment income tax). President Biden is proposing taxing long-term capital gains and qualified dividends as ordinary income for those with AGI above $1 million (single or married). Those in the top income bracket would see their long-term capital gains rate effectively double to 43.4% (39.6% plus the 3.8% net investment income tax) but only to the extent that the taxpayers income exceeds $1 million. This could open the door to planning opportunities with installment sales, charitable remainder unitrusts, and increased charitable giving through outright donations or donor-advised funds.
- Eliminating step-up in basis at death. Under current law, the cost basis of assets (stocks, bonds, real estate) owned by a decedent at death is adjusted (or “stepped-up”) to their fair market value on the date of death. President Biden is calling for a “carry-over” basis instead, meaning inherited property with unrealized gains exceeding $1 million ($2 million for married couples) not donated to charity would be taxed at their applicable capital gains rate. The personal residence exclusion remains available with an additional $250,000 exemption per individual ($500,000 married). For those in the highest income bracket, these gains would be subject to the new 43.4% rate (39.6% plus the 3.8% net investment income tax).
- Estate, Generation-Skipping Transfer (GST), and Gift Tax Proposals. President Biden has proposed lowering the federal estate tax and GST exemptions to $3.5 million (currently set at $11.7 million for estate bequests, GST, and lifetime gifts.) The gift tax exemption could be reduced to $1 million per individual. Lowering the annual gift exclusion of $15,000 per person to $10,000 per year per recipient is also on the table, as well as limiting the donor to $20,000 total in excludable gifts (no matter how many recipients). This would greatly restrict an individual’s ability to make gifts without using lifetime exemption. Now is a great time to have your estate documents reviewed to ensure that your wishes are reflected and any proactive planning including implementing gifting strategies now.
Real estate related
- Reigning in the like-kind exchange (1031 exchange). The President is hoping to limit the like-kind exchange that allows real estate investors to defer taxation whey they exchange property held for investment. The deferral in any one year would be limited to gains of $500,000 for single taxpayers and $1 million for married taxpayers, and any gains beyond this amount would be taxed at the applicable capital gains rate.
Washington State Tax Changes Already Passed:
Unlike the above federal proposals, these tax changes have actually passed in Washington state and are something to consider and plan for now.
- Washington Long Term Capital Gains Tax. The 2021 Washington State Legislature recently passed the tax which creates a 7% tax on the sale or exchange of long-term capital assets (excluding real estate) if an individual’s profits exceed $250,000 annually. A married couple is considered a single individual regardless of filing status for purposes of determining the deduction. Individuals can be liable for the tax as a result of their ownership interest in an entity that sells or exchanges long-term capital assets. It is only applicable to gains allocated to Washington state and takes effect January 1, 2022.
- Washington State Long-Term Care Trust Act. As discussed more thoroughly in our recent blog post, Washington State passed the first ever payroll tax (0.58% on all W-2 income) to fund long-term care needs. We believe this state-specific planning issue relating to long-term care is both timely and relevant to a broad cross-section of Washington state residents. Please don’t hesitate to reach out if we haven’t already spoken with you about this and we can be of help.
We know that there are lot of changes and proposals to navigate, and in uncertain times our tendency can be to either sit back and ignore the uncertainty or act on fear. We’d urge you to fight the desire to make snap decisions, but instead take a step back and view these changes in context of your full financial plan. We know that a strong plan considers how financial planning, investment planning, estate planning and tax planning work in concert with one another. And having a plan that considers all of these elements together is the best way to weather the uncertainty that inevitably comes our way – including federal tax proposals.
In light of these proposed changes, there are three basic but vital steps we are taking to ensure we are in a great position to be advocates for our clients. First, we keep an updated planning profile tracking high-level planning items including a net worth and cash flow analysis– how their assets break down in comparison to state and federal exemption, cash flow in respect to managing tax brackets, etc. We also encourage our clients to make sure they have their estate plans diagrammed out and that they understand the breakdown of where assets and taxes would flow if they were to pass today. Clarity on this is huge with respect to the current tax proposals and any tax planning and gifting strategies that may be available now in front of any tax law changes. Finally, we cannot stress enough the important of regular reviews with our clients to ensure that we have an updated understanding of goals and objectives. These are the waypoints on the road to optimism about life and money.
As always, we are grateful to be advocates in your corner. Please let us know how we can be a resource for you on these specific topics or in crafting an overall plan that makes you feel good and confident about the future. Also feel free to pass on to any family or friends who may be concerned with uncertainty and could use proactive planning and encouragement.
Disclosure: The content of this article is provided for general information purposes only. The information was compiled from sources that we believe to be reliable, however, we cannot guarantee accuracy. Tschetter Group does not provide tax or legal advice. Please consult your legal or tax professional for specific information.