Planning Bulletin: To Be, or Not to Be?

So…now we appear on the verge of having a new President-elect, and with that a new slate of proposals for changes to the Tax Code. This Planning Bulletin will focus on one of those proposals: changes to the taxation of long-term capital gain (LTCG). There are a number of moving parts, and a meaningful uncertainty factor, as well as timing urgency. Notwithstanding, if you have significant unrealized LTCG, whether or not you choose to take an action step, you need to understand the choices.

Mr. Biden has said that he would propose taxing LTCG as ordinary income for taxpayers with income over $1 million (presumably meaning 1040 taxable income). At the same time, he is proposing returning the top rate on ordinary income, from its current 37% to 39.6%. The current LTCG rates for a married couple filing jointly, are 0% up to $53,600; 15% from $53,000 to $469,601, and 20% over $469,601. There is also a tax on net investment income (NIIT) of 3.8%, which would continue to apply. And, of course, this applies to all capital assets, not just financial ones. Note well, this amounts to a whopping 82% increase in the LTCG rate (43.4%/23.8%)! Note also, that while you might not normally have taxable income of $1 million or greater, by selling those assets, you could easily push yourself over that level.

Additionally, he favors doing away with the step-up in basis to fair market value at death. As a quick review: At death, all assets in a decedent’s estate are valued at current fair market value, which becomes their cost basis for tax purposes. As a result, when those assets are distributed to heirs, they can be sold at no capital gains cost, no matter how much unrealized appreciation they previously contained. Biden’s proposal here is somewhat vague. There are two interpretations of it: 1) At date of death appreciated assets will be “marked to market” with capital gains payable by the estate at that point. So, the tax basis of the assets are stepped up to fair market value, but at a steep price; 2) And a much softer approach, to simply pass the assets on to heirs with their existing, or “carryover,” basis. This defers the tax burden to such time as the assets are eventually sold but does not expunge the unrealized capital gains tax, as current law does. • Finally, politics are very much in play here. As most know, Republican control of the Senate hinges on two runoff elections in Georgia, which will not occur until January of next year. Republicans will retain control unless the Democrats win both seats. This is important because unless the incoming Biden Administration has control of both Houses of Congress it is considerably less likely that it could pass meaningful changes to capital gains taxation. So……the alternative outcomes are: The dice come up snake eyes with both Houses of Congress and the chief executive office all in Democratic hands. This could end poorly for the many holders of highly appreciated assets. Assume a worst case, where the harshest of Biden’s capital gains tax proposals become law: A person dies with an estate containing highly appreciated assets. If the gain in those assets were taxed at his death as ordinary income at 43.4% and at the same time assessed a federal estate tax of 40% (assuming it too does not increasei ) and further assuming there would be no credit for the income tax paid against the estate tax due (and there might or might not be) assets left for heirs would be given a hair cut by as much as 83.4% (43.4% + 40%). Goodbye wealth inequality! …. or do the Republicans hold the Senate and the worst of these proposals die on the cutting room floor?

And herein lies the dilemma: There is a good chance that should draconian capital gains taxation be legislated, it would be retroactive to 1/1/21. That means that if one wanted to take the obvious preemptive action of selling appreciated assets in 2020 to beat the sheriff, they are assuming the risk that these changes never actually do get implemented and they end up with much mud on their face in the form of a big, unnecessary capital gains tax bill! On the other hand, if those changes do get implemented, they have indeed beaten the sheriff.

I personally think it unlikely that the Democrats will flip the Senate, but you may disagree, or not want to take the chance. At any rate, while Fieldpoint does not provide tax or legal advice, there are decisions to be made! I do suggest discussing with your tax counsel.

Nicholas J. Bertha JD
Director of Wealth and Trust Planning

i. Historically, for many years (1940-1976) it was 77%.
ii. Of course, higher-level economic or investment management factors could override this.


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