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Are You Prepared for the Potential Tax Changes on the Horizon?

Are You Prepared for the Potential Tax Changes on the Horizon?

August 05, 2021

It’s not unusual for Americans to see a flurry of legislation changes after a presidential election when one party replaces the last in a new administration. This year is no exception. We are almost eight months into President Biden’s administration—and still waiting to see if the changes he proposes in the American Families Plan will come to pass. While some of his proposed changes are still unclear, below are the basic changes that you should be aware of and prepare for in the event they come to fruition.

Higher Income Tax Rates

The current income tax rate for 2021 is 37 percent for the highest income tax bracket (income that exceeds $523,600 for individuals and those married filing separately, or $628,300 if you’re married filing jointly). Biden’s proposed hike to 39.6 percent is one potential change that concerns those in this tax bracket. If his plan comes to pass, the income ceiling lowers a bit and impacts quite a few more people. For example, that 39.6 percent tax will impact those who are married filing jointly with earnings of $509,000 a year ($400,000 for individuals)—and that will be the tax levied on all their income.

Change in Capital Gains Tax Rates

President Biden’s plan also proposes a significant change in capital gains tax that targets wealthy individuals with taxable income of $1,000,000 or more ($2,000,000 if you’re married). Currently, capital gains are taxed at a rate of 20 percent. Biden’s plan, if approved, will include capital gains as ordinary income, which means those gains will be subject to his proposed new tax rate of 39.6 percent. Now, there may be some exceptions that have yet to be clarified. But, plainly speaking, those with $1,000,000 or more in income—regardless of where that income comes from—will pay 39.6 percent tax on their earnings if this law comes to pass. 

End of Step-Up in Basis on Gifted and/or Inherited Gains

The “step-up” in cost basis for inherited and gifted assets allows the value of those assets to be updated and assessed based on the fair market value of the asset/s at the time of the benefactor’s death and not based on the cost of the asset when the decedent purchased it. Commonly referred to as the step-up in basis rule, this reduces capital gains tax levied on the inherited property for the beneficiary.

Biden’s plan would eliminate the step-up basis and tax gains passed to heirs that exceed $1 million ($2 million if you’re married) unless the property is donated to a charity. This change impacts inherited and gifted gains on property owned by individuals and would tax the donor’s estate based on the value of the property on the date of the donor’s death, after factoring the $1,000,000 exemption and minus initial cost basis of the property. If the estate can’t pay that tax, the heir may be forced to sell that asset to do so.

For example, if you inherit a property from your deceased mother that she paid $200,000 for but is worth $1,500,000 when she dies: Under the current step-up in basis provision, you owe no capital gains whether you keep or immediately sell the property. But Biden’s plan would impose a tax on $300,000 (the value of the property after accounting for the $1,000,000 exemption minus the $200,000 the property initially cost your mother). That tax would be owed by your mother’s estate, but if there weren’t sufficient funds to pay it, you might be forced to sell the property to pay that tax.

Moving Forward in Anticipation of the Passage of the American Families Plan

Biden presented the American Families Plan to congress in April 2021. However, at the time of the writing of this article, Americans still don’t have a clear indication as to whether some (or all) of these proposals will be passed in full or in part. At the very least, people are (and should be) concerned about the possibility of millions of dollars of earned income, along with capital gains being counted as ordinary income, and paying tax on both at the proposed higher rate.

If you’re income bracket is in the top tier, the potential hike in tax rates can put a significant dent in your ultimate financial plan to date. And the end of the step-up in basis might significantly impact the estate you leave to your beneficiaries.

And listen—because tax laws are complex (especially when it comes to wealth planning)—it’s important to meet with your financial planning and/or tax advisor in time to learn how to prepare in case these proposals become reality. For example, if you receive a year-end bonus that’s typically paid out in January, ask your employer if that can be paid in December 2021 to take advantage of current tax laws. Perhaps you should reconsider selling the family business 5 years down the road and sell it this year. Or maybe some of your assets could be properly distributed to your loved ones now instead of on your death. Annuities may become more attractive (or appropriate) to supplement retirement planning tools like Roth and traditional IRAs. The thing is, you must understand and anticipate possibly implementing additional tax deferral and diversification strategies that can mitigate the impact of the proposed tax hike and help you protect your hard-earned wealth.




This article was written for informational purposes only and should not be considered tax planning, investing, or financial planning advice. Please seek advice from appropriate professionals to determine how current and potential tax laws can impact you.