This week, RFA’s Director – Financial Planning, Gabe Adams, CFP®, MSPFP, covers four tax changes that have been proposed and what they could mean for you if passed.

Transcript

Hi there, I am Gabe Adams, the Director of Financial Planning at Reilly Financial Advisors. There has been a lot in the news recently about possible tax changes. Today, I will review a few of the proposed tax changes being discussed in Washington. I will also address if there are any strategies you can consider.

Potential Change #1 – Ordinary Income Tax Rates

The first change has to do with ordinary income tax rates. Ordinary rates are assessed on items such as your paycheck, retirement account withdrawals, and up to 85% of Social Security benefits. There is a proposal in the works to raise the top marginal bracket from 37% to 39.6%, on income above $400,000 for single filers and $450,000 for married filers. What that means is that for any dollar of income above those thresholds, you would owe 39.6 cents of taxes.

  Income Tax Rate Taxable Income (Single) Taxable Income (Married Filing Jointly)
Current Top Marginal Rate 37% $523,601+ $628,301+
Proposed Top Marginal Rate 39.6% $400,001+ $450,001+

Potential Change #2 – Long Term Capital Gains Rates

Another potential change involves long-term capital gains rates, which are assessed on realized gains from the sale of a capital asset, such as stock, that is held for more than one year. Qualified dividends, which can be received when holding public stock, are also taxed at these rates. The top rate could increase from 20% to 25% on income above $400,000 for single filers and $450,000 for married filers. When combined with the 3.8% net investment income tax that is assessed for certain high earners, the top long-term capital gains rate would come in at 28.8%. New rates could be retroactive to September 13, 2021.

  Long-Term Capital Gains Rate + Net Investment Income Tax Taxable Income (Single) Taxable Income (Married Filing Jointly)
Current Top Long-Term Capital Gains Rate 20% + 3.8% = 23.8% $445,851+ $501,601+
Proposed Top Long-Term Capital Gains Rate 25% + 3.8% = 28.8% $400,001+ $450,001+

Potential Change #3 – Estate and Gift Taxes

Another change being considered would affect estate and gift taxes. We have what is known as a unified estate and gift tax lifetime exemption, currently at $11.7M per person and $23.4M per married couple. In essence, think of this as an allowance for tax-free transfers during life and at death. Amounts transferred above the threshold are taxed at a rate as high as 40%, although less than 0.1% of estates owed estate taxes in 2020. It’s possible that the lifetime exemption could be reduced by 50%, which would be a reversion to 2017 law. There has also been some previous talk of the top estate tax rate increasing from 40 to 45%.

  Single Married Top Tax Rate
Current Estate/Gift Tax Exemption $11.7M $23.4M 40%
Proposed Estate/Gift Tax Exemption $5.85M $11.7M 40 – 45%

Potential Change #4 – Other Transfer Taxes

Finally, another previously discussed change also involves transferring assets by gift or upon death. Under current law, gifts which carry unrealized capital gains are not immediately taxed, as the gains carry over to the recipient. Unrealized gains also receive an unlimited step up in basis. This means that the cost basis of an asset would equal, or step up to, the fair market value at death. This is favorable for beneficiaries, as those unrealized gains are removed. Initial proposals would eliminate these rules and, in some cases, make transfers by gift and by death taxable events. However, the latest iteration coming out of Washington does not appear to include any changes to these rules.

So, if you believe that you could be affected by any tax changes, what strategies can you consider? From a planning standpoint, I would advise caution. We do not know which of these proposals will pass. If proposals do pass, we do not know what they will look like in their final form. That said, do not take action that will put you in a worse off position if changes do not come to fruition. One example I can think of is immediately selling a stock position with a large unrealized capital gain because you feel long-term capital gains rates are certain to increase. This could cause you to incur significant taxes.

The legislative process could take months, and one thing you can do is become educated and prepared. RFA will continue to stay on top of the conversation in Washington, and I encourage you to talk with your advisor if you have any questions or concerns. As the process moves along and we have more clarity, we will be prepared to act if needed. Thanks so much for listening in, and I will see you next time.

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