President Joe Biden’s freshly-released American Families Plan is long on specific ideas, such as universal preschool, two free years of community college and paid parental leave.
It’s also packed with particulars on the ways Biden would fund the $1.8 trillion proposal, including a new top income tax rate, a capital gains rate hike for millionaires and extra IRS enforcement of tax scofflaws.
Wealthy taxpayers and their financial planners have already been bracing for the prospect of more taxes and more audits during the Biden administration, but one big question looms: What will the effective date be for any tax law changes?
Plan details released Wednesday by the White House did nothing to erase that question. That matters for wealthy individuals and their advisers. But it also potentially matters for investors and even blank check firms eyeing companies to purchase.
Of course, it would be quite difficult for the White House to say with certainty now what any effective dates would be. The American Families Plan is at the beginning of the legislative process and its final contents and tax rates, let alone passage, isn’t guaranteed.
“We’d like to see it pass as soon as possible,” on senior administration official said when debriefing reporters on Biden’s new proposal. “All of this begins at passage,” the official added.
Biden’s proposal would put the top income tax rate back at 39.6%, the rate before the 2017 Trump tax cuts lowered it to 37%. Households making more than $1 million would have a 39.6% capital gains tax, plus a pre-existing 3.8% tax linked to the Affordable Care Act.
Right now, top earners pay a 20% capital gains tax when selling an investment security they’ve held for at least one year.
Until an effective date is known, these investors don’t have a sell-by deadline if they want to pay a lower tax rate. There could be a $178 billion stock market sell-off ahead of any capital gains hike, one estimate said.
It’s common for high-net worth individuals to maintain a kind of “capital gains budget,” to prepare for any tax bill surprises, explained Ali Hutchinson, managing director at Brown Brothers Harriman, a private bank with super-rich clientele.
“If you don’t know the timing and you don’t know the percentage, who can manage client expectations on what to set aside for capital gains next year?” she said.
Biden also wants to end the “step up in basis” for gains above $1 million, or $2.5 million for married couples. When an asset — like stock shares, art or other property gaining value — is passed to an heir, there’s a reset for capital gains tax purposes.
If the heir sells the asset, the tax is calculated based on the rise in value since the heir acquired it, not when it was originally acquired. That allows heirs to sidestep a lot of would-be capital gains tax for something that’s grown greatly in value over generations.
“The old plan was a simple plan. It didn’t require an accountant. It was die with it,” Hutchinson said. But if lawmakers strike down the step-up, Hutchinson said, older investors might need to think about potentially selling and diversifying in order to avoid passing on a tax bill.
But, again, they lack a clear timetable now on when to act, she noted.
White House materials say proposed changes to the step-up rules will include “protections so that family-owned businesses and farms will not have to pay taxes when given to heirs who continue to run the business.”
Hutchinson’s clients already can’t stop thinking about how that might apply to their own family businesses, she said.
If there is a market sell-off before tax law changes, there could be buyers. Wealthy investors have a lot of cash on hand and are increasingly ready to boost their stock market exposure, a new UBS survey shows. Meanwhile, a new crop of young retail investors could also be eyeing bargains if any tax-strategy induced sell-off creates buying opportunities.
Capital asset sales have jumped ahead of previous capital gains rate hikes.
Sales or, capital gains “realizations,” increased 60% in the 1986 tax year ahead of a 1987 rate increase, according to research from the nonpartisan U.S. Congress committee Joint Committee on Taxation and the Tax Policy Center, a think tank. Sales jumped 40% ahead of a 2013 rate hike.
There’s an interesting mix of market ingredients this time, Hutchinson said. Special-purpose acquisition companies “are holding pools of liquidity and looking for acquisition,” she noted.
None of her business-owning clients wants to sell just because of the prospect of more taxes, Hutchinson said. But for anyone who’s already inclined, the chance of higher capital gains rates and no step-up are a powerful nudge.
“If I was already thinking its time, why not accelerate that into 2021, as opposed to 2022?” Hutchinson said. “And there are buyers, there is liquidity.”
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