The recent power shift in Washington D.C. may leave high-income individuals wondering what moves they should make to protect and enhance their assets, in the event that changes may be enacted to tax laws that could significantly affect estate planning and other key facets of personal and business income taxes.
"This year should be a year of preparation," said Alan Wolberg, head of wealth planning strategy at City National Bank. Since changes in tax law typically go into effect in the year following their passage in Congress, any legislation approved in 2021 will likely begin to affect taxpayers in 2022.
If you're interested in staying ahead of possible changes, it's a good idea to have a proactive conversation with your banker, CPA and lawyer to help fortify your finances and ensure you're on good footing regarding financial decisions you may have made in connection with the pandemic, Wolberg said.
While no specific legislation has been introduced yet, Wolberg said some policymakers have promised to reverse major components of the 2017 Tax Cuts and Jobs Act, 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, Wolberg said.
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, Wolberg said.
Policymakers also could 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, Wolberg explained.
If they are introduced and become law, the proposals to eliminate the step-up in basis and to halve the estate and lifetime gift tax exemption could cost wealthy families millions, Wolberg said.
For instance, consider a $15 million estate of an unmarried taxpayer with an original $5 million cost basis.
Under current law, the transfer at death of that estate from a single Californian to another California resident 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.
Anyone with a big estate who has not developed a well-tailored tax plan should get started early, advised Wolberg, noting that it can take months to get all the documents together and filings completed. Many high-net-worth taxpayers are creating new plans now and waiting to sign them, pending the outcome of tax proposals, according to Wolberg.
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 high earners.
• 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," Wolberg said.
He also noted 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, Wolberg said.
With legislators looking to increase the capital gains tax, it might also 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 — Wolberg said.
"This would be the year to talk to your wealth planning team and tax advisors about how to structure that sale," he said.
City National Bank wealth planners have been discussing with clients and their other advisors these and other strategies, 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 — Wolberg said.
"If you bring back these deductions then you need to start keeping track of them again," he said.
Clear record-keeping also is vital for businesses that participated in the federal Paycheck Protection Program, which Congress passed last year to help employers maintain their staffs through the coronavirus pandemic. Documentation covering payroll, tax filings and spending on employee benefits, rent, utilities and personal protective equipment, among other costs, all could 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," Wolberg said.
Congress in December 2020 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've 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.
Meanwhile, City National Bank encourages you to consult with your banker, financial advisor and tax professional as you navigate these complex financial issues.
Need to discuss your wealth plan with an advisor and wish to find one? Get in touch with a City National advisor today.
You also are invited to keep up-to-date with the latest economic perspectives and shifting global markets during the pandemic by signing up for City National Bank's newsletters here. Delivered biweekly, straight to your inbox.
This article is for general information and education only. It is provided as a courtesy to the clients and friends of City National Bank (City National). City National does not warrant that it is accurate or complete. Opinions expressed and estimates or projections given are those of the authors or persons quoted as of the date of the article with no obligation to update or notify of inaccuracy or change. This article may not be reproduced, distributed or further published by any person without the written consent of City National. Please cite source when quoting.
City National, its managed affiliates and subsidiaries, as a matter of policy, do not give tax, accounting, regulatory or legal advice. Rules in the areas of law, tax, and accounting are subject to change and open to varying interpretations. You should consult with your other advisors on the tax, accounting and legal implications of actions you may take based on any strategies presented, taking into account your own particular circumstances.