There’s a new administration in Washington D.C. and you don’t need a crystal ball to realize major tax changes are on the horizon. The good news, relatively speaking, is that any changes are NOT expected to be retroactive to January 1, 2021. Nothing specific has been proposed yet, which means nothing has been acted upon, so any changes are more likely to take effect on January 1, 2022 or later, which gives individuals and businesses time to prepare and plan.

Here’s what we see as some of the items currently on the table at the federal level:

On the income tax side, the critical number being floated involves higher taxes for incomes over $400,000. At present, it’s not clear whether that’s joint income or single income. If you’re in that range, you might consider accelerating some of your income into this year.

The Trump tax brackets are expected to change as well, though maybe not that much on the lower end of things. The most likely change is a shift from the 12% bracket back up to 15%.

Related to capital gains, the number to keep an eye on is capital gain incomes in excess of a million dollars. This is especially impactful if there’s a sale of a business, or a large stock transaction that spikes income. In such cases, you may want to move the transaction to this year (if possible) versus waiting until 2022.

Roth conversions for those individuals at the high end of the income spectrum may make sense for accelerating income to this year. Even for those in more moderate brackets, such as 35% or 32%, the reward for converting in 2021 could be much higher than if you waited until next year.

The Tax Cuts and Jobs Act of 2017 provided an individual estate tax exemption amount increase up to $11.7 million in 2021 for estate, gift, and GST (generation skipping transfer) taxes. As it now stands, individuals can transfer up to $11.7 million of assets during their lives and at the time of death without having to pay federal estate, gift, or GST taxes. Married couples can transfer twice that amount. This federal exemption is already scheduled to revert to $6 million on January 1, 2026, but the word from Washington is that it could revert to $6 million (or even lower) much earlier than that. A lower Estate Tax exemption means your Estate could end up paying major taxes upon your passing in what amounts to a “death tax” for anyone who owns more property than the Estate Tax exemption.

There’s also talk about eliminating the basis step-up for inherited property. When someone inherits an asset after the benefactor dies, that asset is often valued with what is called a “stepped-up basis” to avoid paying capital gains taxes. This strategy is often applied to real estate, securities, and practically anything of significant value. For example, let’s say you bought a house in the 1970s for $120,000 and its current fair market value is $850,000. Upon your passing, it’s inherited by your children and sold immediately. Under the existing basis step-up law for inherited property, your heirs would pay ZERO capital gains because any gains would be wiped out by using the current fair market value as the basis (or purchase price). Under anticipated changes, however, if the basis step-up is eliminated, using the same scenario described above your heirs would pay capital gains taxes on $730,000 (the current fair market value of $850,000 minus the original purchase price of $120,000), or about $225,000!

Another possible big change we’re watching would replace the current tax break/deduction for traditional IRAs and 401(k)s with a flat, revenue-neutral credit. To illustrate, someone at the 37% bracket today who saves $10,000 in an IRA or 401(k) sees their tax bill reduced by $3,700. Presumably, any flat amount would offer substantially less tax savings.

We may also see the sales of businesses structured as multi-year transactions spread over time rather than one-and-done transactions to avoid bumps in income levels that could result in undesired capital gains implications.

Lastly, but certainly not least, if some or all of these tax changes are enacted, investment strategies may need to change. We may see more Roth conversions this year. Investment-only variable annuities may become more valued. Dividends could become less attractive because of the income they generate, and investments in municipal bonds and life insurance assets may become the answer for some.

What Can Be Done Now?

Business owners or even individuals will want to explore ways to restructure their businesses or personal assets to lessen their tax liabilities, and the sooner the better it seems. How that’s done, of course, depends on the unique circumstances of each situation.

While we don’t know fully what the final federal tax changes will look like, we know enough to make some well-informed assumptions. Planning and preparation is key.

Questions that need answering include:

  • What is your anticipated income for 2021, 2022?
  • What assets do you now hold? What are their values?
  • Do you plan to acquire more assets or sell those you now possess?
  • Do you own a business? Do you have an exit strategy, a succession plan?
  • Are Estate Plans up to date? What might need to change in lieu of anticipated changes?

Got Questions?

If you have questions about how changes in federal tax laws might affect you or your business, we can help. The attorneys at Shoup Legal are experts at Estate Planning and helping clients secure their assets and protect their heirs. Contact us at (951) 445-4114 or email us at [email protected] to discuss your unique situation today.