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Tax policy used to be quite boring and predictable. But over the past decade, it has become vibrant in a way that tax advisers don’t like: It changes with the political party in power.
This means that it is increasingly difficult for people who are trying to make long term decisions about their income, savings and donations. And advisers are likely to advise on the best decision right now, because the future is too hazy.
Shortly after Joseph R. Biden Jr. was declared president-elect in November, I wrote a column on the opportunity costs of making tax decisions. It was not easy then to know the best tax strategies.
At that time, the deciding factor was whether the Democrats would take control of the Senate through two second-round races in Georgia. Few were willing to predict that the two Democrats would beat the incumbent Republicans, but that is what happened. And their victories have given Mr. Biden a clearer path to carry out his agenda.
So the question for taxpayers now is: What happens once Mr. Biden can start making changes in tax policy?
“It’s really hard to predict at any time how Congress will react in terms of fiscal policy; it’s especially hard to predict this year, ”said Howard Gleckman, senior researcher at the Tax Policy Center, a joint venture of the Urban Institute and the Brookings Institution. “But I have a feeling that it will be easier in the current political dynamic to get the tax cuts he talked about rather than the tax increases.”
The caveat is that the Biden administration has plenty on its pre-tax agenda, namely the coronavirus pandemic and its vaccination rollout, as well as strengthening the fragile economy and stabilizing the uneven recovery of jobs.
“We’re not going to see massive tax changes because there are more pressing things to fear at this point,” said Brian Glavotsky, a tax partner in family office services at Wiss & Company, an accounting firm.
Other analysts have suggested that if the pandemic looks better by the end of the summer, then the tax changes could be addressed.
With that in mind, perhaps the best way to think about what to do in 2021 is to think about what you need to do in the short, medium, and long term. There is a lot to think about, so I will divide this topic into two columns. This week I’m going to look at the long term issues; next week, I will address more immediate tax issues that may arise this year.
The biggest potential long-term change is in estate tax. But unlike previous changes, the tax code could be changed in a way that affects anyone with something of value to leave to the heirs.
For decades, assets were valued when the owner died, even though the value had increased. This so-called base rise rule works as follows: if a stock bought for $ 1 is worth $ 10 when the owner dies, the gain is $ 9. But when that asset is passed on to the heirs, the embedded gain is erased because the base value is now $ 10 and no capital gains tax is due.
This treatment applies to everything from liquid securities and private investment partnerships to the family home. If the total estate value is less than the current exemption level of $ 11.7 million for an individual or $ 23.4 million for a couple, no inheritance tax should be paid either.
A Biden administration can change this for logical and revenue reasons. At one point, stepping up the base made sense. Imagine trying to determine the capital gains of the AT&T shares your grandmother bought in 1943 when record keeping was done with pencil and paper. Today, cost-based information can be retrieved in seconds.
But two different groups of people have expressed concern about the loss of the loophole: the very rich and the moderately rich.
If you’re Jeff Bezos or Elon Musk, the two richest people in the world, having your long-term holdings in Amazon and Tesla with an increase in the base is a huge saving on capital gains tax because they will pay estate tax no matter what.
But for people of more modest wealth, say someone lucky enough to inherit a house or a stock portfolio, the step-up loss could be even greater.
Robert S. Seltzer, founder and president of Seltzer Business Management in Los Angeles, said when his mother passed away, he inherited his home at the top of the real estate bubble. The initial cost in the 1970s was less than $ 70,000, but the house had appreciated to around $ 500,000. By the time he sold the house in 2010, it was worth $ 200,000 less.
“I actually suffered a capital loss when I sold it,” Mr. Seltzer said. If I had not received the increase in the Basic Tax Benefit, “I would have had to pay capital gains of $ 350,000 to $ 400,000 because I would have inherited the base $ 70,000 from my parents.”
For the black community, the prospect of an heir paying a capital gains tax on inherited property could help maintain the racial wealth gap, said Calvin Williams Jr., CEO and founder of Freeman Capital. He noted that the average black family passed on $ 38,000 to heirs, while the average white family passed on $ 140,000.
Losing the base increase would have an even greater impact on efforts to close the black wealth gap, Williams said.
“We need every penny to make this transfer,” he said. “I understand and appreciate what they’re trying to do, but it’s a big hammer right now. If it were more narrowly targeted, it would be more beneficial for the communities.
If this change materializes, richer people could trade the assets they trust, said Edward Reitmeyer, partner in charge of tax and business services at Marcum, an accounting firm. People with access to more sophisticated planning could place assets with larger embedded capital gains in a trust and leave other people – like cash – directly to the heirs.
This strategy would minimize the capital gains tax that their heirs would pay. But it’s not hard to see how people who don’t have access to sophisticated tax planning would be affected by the tax.
For the very rich, the concern about inheritance and gift taxes is that the level of federal exemption will be lowered – Mr Biden has said as much – and that the tax rate could be increased.
With Democrats in control of the legislative and executive branches, there are fears the exemption level could drop to $ 5 million, or even $ 3.5 million, from where it was when President Barack Obama took office. (The current level, which was set in the 2017 tax review, is expected to disappear in 2025.) For the wealthiest in the country, the biggest concern is the rate itself. It is now 40%, but it was as high as 55% in 2001.
The possible changes in the exemption rate have weighed on wealthy Americans, who must choose to use the tax advantage now to make a big donation before any changes become law or wait and see how the year unfolds.
Some wealthy people fear that a Biden administration could make the inheritance and gift tax changes retroactive to Jan. 1, said Marya P. Robben, partner at the law firm Lathrop GPM. In anticipation, they are looking to give big gifts now to take advantage of the gift tax exemption.
“If I haven’t given it away sooner, I should do it now,” Ms. Robben said of her clients’ state of mind. “If the change in inheritance tax is not retroactive, I’m better off. If it’s retroactive, I’m no worse off than now. “
But others bet against any retroactive modification of inheritance and gift taxes. “Congress can do what it wants, but Congress rarely applies tax increases retroactively,” Gleckman said.
Mr Reitmeyer said Democrats’ tight control over the Senate would also serve as a bulwark against retroactive changes. “I think there are a lot of centrists out there who really don’t go for that,” he said.
How the votes in Congress move, especially around short and medium term strategies, will be the focus of next week’s column.
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