The “American Families Plan” White House press release on April 28, 2021, introduced various noteworthy tax policy proposals. While these proposals as part of Biden’s tax plan are unlikely to be enacted in their current form, the themes are worth discussing with your financial advisor as are proactive strategies you may wish to consider as an American taxpayer.
What is Biden’s tax plan? At a high level, the American Families Plan focuses on a few key areas of taxation:
Since these tax reform proposals are just that, it may not be worth focusing on the specific dollar thresholds in question, but rather the ways to plan around them. Also, we have not yet seen negotiations in other areas of tax policy agenda items, such as the phasing out of itemized deductions, getting rid of the “SALT” cap (State and Local Tax), limiting valuation discounts, or bringing down the lifetime estate tax exemption amount, to name a few.
It may be useful to begin with an overview of the typical tax strategy for an individual taxpayer each year. As a general rule, most tax CPAs suggest attempting to defer income to a future tax year and accelerating expenses in the current tax year. Deferring income might include things like using 1031 exchanges with real estate, installment sales of businesses and 10b5-1 stock option planning. Accelerating expenses might include bunching charitable giving or medical expenses in the current tax year, using bonus depreciation on purchases, or harvesting capital losses in a portfolio.
If certain tax policy proposals from Biden’s tax plan were to be enacted in 2022, and not applied retroactively in 2021, we might see the triggering of long-term capital gains, exercising and sales of stock options, triggering of business sales and a burst of M&A activity, a surge in real estate 1031 exchanges, business distributions, and Roth IRA conversions. These are all activities that would be made to accelerate income in the existing, more tax favorable environment.
On the flip side, certain expense items might be subject to deferral if these tax policy proposals were to be enacted in 2022. If Biden’s tax plan were to be passed, examples of what we could expect include deferring tax loss harvesting, bunching itemized deductions in a future year and/or planning around paying state income taxes and property taxes in 2022 if the SALT cap were to be lifted. We might also see more installment sales in future years to spread out and defer gains as well as more maxing out of contributions to retirement plans, HSAs, and cash balance pension plans.
When it comes to estate planning strategy for those with significant estates, we might see acceleration of gifting or sales to defective grantor trusts, greater consideration for charitable trusts, larger outright family gifts and debt forgiveness. With Biden’s tax proposal, we would also expect more diligence around annual gifting to family members, paying directly for medical and educational expenses of the entire extended family, super-funding 529 college savings plans, and the creation of larger Donor Advised Funds (DAFs) and private family foundations.
If the step up in basis were to be limited at death, we might also see a concept called “income smoothing” for the elderly high net worth client in future tax years. “Income smoothing” is where a certain amount of capital gains are realized annually just below a new threshold for the highest marginal tax rate, so as to leave a smaller amount of unrealized gains that would then be left in one’s estate at death. This could be planned to fall below the threshold for the step-up limitation.
There might also be more consideration of proactive charitable planning structures for those wealthy Americans with potential taxable estates. For instance, clients may set up a charitable remainder trust (CRT) for a future property sale or using a CRT as a beneficiary of an IRA to provide the client or beneficiary a future income stream spread out over many future tax years. With Biden’s tax proposal, we may also see more private family foundation creations for the ultra-high net worth individuals, allowing these affluent Americans to receive a significant charitable deduction for the contribution of appreciated stock, and then having the ability to maintain control of the foundation’s wealth, in hiring staff, including family members for reasonable compensation.
On the more straightforward side of charitable giving, we might see an increase in the gift of appreciated stock into Donor Advised Funds if tax rates were to go up. We might also see the naming of a DAF as beneficiary of a traditional IRA to continue a legacy of family charitable intent combined with a reduction in one’s taxable estate.
Finally, we may also see more strategic gifting to family members from the high-net-worth client who have not yet used any of their lifetime estate tax exemption amount, currently set at $11.7M per person. Some clients may consider gifting a portion of their lifetime exemption amount now (e.g., $5.7M) if the future exemption amount were to sunset in 2026 down to an inflation adjusted $6M per person (i.e., leaving $6M per person in tax-free value). A spousal lifetime access trust could be another possible strategy in this regard. If Biden’s plan is approved, we may also see more proactive creation of intentionally defective grantor trusts (IDGTs) for valuation discounts and to freeze assets and transfer wealth before tax policy is enacted that could impact that area of estate planning.
All in all, it is an interesting time to consider the complexities of tax law, as well as estate and charitable planning strategies. Contact a financial advisor at Dowling & Yahnke for more information on the various concepts and ideas that are relevant to your taxable income and overall financial life and well-being.