Ushering in a new government brings with it the potential for changes to tax laws. Given tax reforms could impact personal and business income taxes, some high-income individuals may be wondering what their next move should be.
“This should be a year of preparation,” says Paul DeLauro, head of wealth planning strategy at City National Bank. Since tax law changes typically go into effect the year following their passage in Congress, any legislation approved in 2021 will likely affect taxpayers in 2022.
If you're interested in staying ahead of possible changes, it's always a good idea to have a proactive conversation with your financial advisor, CPA and lawyer to help fortify your finances. You'll want to ensure you're on good footing regarding financial decisions you may have made in connection with the pandemic, says DeLauro.
What are the possible tax changes ahead?
While no specific legislation has been introduced, DeLauro says some policymakers have promised to reverse major components of the 2017 Tax Cuts and Jobs Act (TCJA), which included an array of middle-income tax cuts and high net-worth estate tax benefits.
Federal tax legislation proposals that might surface this year could cut the $11.7 million estate and lifetime gift tax exemption by half or more. While the exemption, which roughly doubled under the TCJA, is due to revert as of Jan. 1, 2026, some legislators aim to accelerate that timetable, likely to 2022, DeLauro says.
A single taxpayer with an estate greater than $6 million—or a married couple with at least $12 million—should meet with their attorney and wealth planning team for a detailed conversation about gift taxes and the potential effects on their heirs if a lower exemption goes into effect.
DeLauro says policymakers could also potentially eliminate the “step-up” in basis, which enables heirs to sharply curb capital gains taxes on inherited assets by setting the basis by which their value is calculated to the day the benefactor died, rather than to the purchase date of the asset. This change could possibly create “a whole new wealth transfer tax,” allowing the government to materially increase its tax revenue over what it currently derives from estate and gift taxes.
Protecting your estate
If any proposals are introduced and become law, they could cost high-net-worth (HNW) families millions, says Bill Ringham, director of Private Wealth Strategies at RBC Wealth Management-U.S. For instance, consider a $15 million estate of an unmarried taxpayer with an original $5 million cost basis.
Under current federal law, the transfer at death of that estate from the decedent to their beneficiaries would cost the estate $1.32 million in federal estate taxes and no capital gains taxes (assuming the heir sold all the assets immediately after the benefactor's death). By eliminating the step-up in basis for long-term capital gains and cutting the gift tax exemption to $5.6 million, the family's total tax bills on the same inheritance could reach as high as $7.14 million.
DeLauro says anyone with a large estate who has not developed a well-tailored tax plan should get started early. It can take months to get all the documents together and filings completed. Many HNW taxpayers are creating new plans now and waiting to sign them, pending the outcome of tax proposals, according to DeLauro.
“Because of the uncertainty of any potential tax law changes, this will be a challenging year for planning,” Ringham says. “But being flexible and having options is key.”
Potential changes coming up the legislative pipeline could also:
- Raise the top marginal income tax rate to 39.6 percent from 37 percent, starting with those earning more than $400,000. The top rate for 2021 applies to individuals earning more than $523,600, or more than $628,300 for married couples filing jointly.
- Eliminate the 20 percent long-term capital gains tax rate and replace it with the 39.6 percent ordinary income tax rate for individuals whose adjusted gross income exceeds $1 million.
- Return the corporate tax rate to 28 percent from the current 21 percent.
- Lift current caps on deductions for state, local and real estate property taxes.
- Increase deductions for charitable giving.
- Cut the standard deduction, which nearly doubled under the Tax Cuts and Jobs Act. The standard deduction for 2021 is $12,550 for single filers and $25,100 for married couples filing jointly.
Regardless of the laws enacted, taxpayers can develop strategies now to help make the most of the changes or mitigate any unfavorable consequences.
“For example, if you're a business owner facing higher corporate taxes, you might consider accelerating income into 2021,” DeLauro says.
He also notes how entrepreneurs who typically pour earnings back into their businesses might consider waiting until 2022 and, instead, pocket some of the cash this year.
The same strategy would work this year for high earners aiming to protect personal income from a possible increase in the top bracket, which could take effect in 2022, DeLauro says.
Preparing to sell and gift assets
With legislators looking to increase the capital gains tax, it might make sense to consider speeding up any large sale you've been considering—a business, land or any other asset that could generate a capital gain—says DeLauro.
“This would be the year to talk to your wealth planning team and tax advisors about how to structure that sale,” he adds.
RBC Wealth Management financial advisors have been discussing strategies with clients, including accelerating gifts to children while the higher estate and lifetime gift tax exemption remains in place.
Higher deductions for state, local and real estate taxes and charitable donations should benefit those earning more than $550,000, and will necessitate more detailed record keeping, DeLauro explains.
“If you bring back these deductions then you need to start keeping track of them again,” he said.
Keeping track of your finances during the pandemic
Clear record-keeping is also vital for businesses that participated in the federal Paycheck Protection Program, which Congress passed last year to help employers. Documentation covering payroll, tax filings and spending on employee benefits, rent, utilities and personal protective equipment, among other costs, could all prove important.
For example, if business owners can show they maintained employee compensation, spent at least 60 percent on payroll and directed the rest to other eligible expenses, they may qualify for loan forgiveness once the funds are exhausted.
“You've got to start keeping track of every penny and the flow of all those pennies,” DeLauro says.
On December 2020, Congress clarified that employers won't have to pay income taxes on forgiven PPP loans and will be able to write off payroll and other expenses they paid with the proceeds, the U.S. Chamber of Commerce noted recently.
Individuals who have been working remotely in a state different from their normal workplace, meanwhile, may face unexpected consequences related to state tax withholding and their particular states' remote-working laws. They may also owe municipal, county and school taxes.
Those are but a few of the tax questions that may arise from the COVID-19 crisis.
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