I often mention taxes in these columns, and in particular the importance of preparing for and managing your tax bill in retirement. With so much of American’s money saved in qualified retirement plans (like a 401k) which have not been taxed, these accounts are often referred to as a “ticking time bomb”. Once you need to start drawing money out of these accounts, they will be fully taxable and this can set off a domino effect of additional tax considerations, such as increasing taxes on your Social Security benefits, higher Medicare premiums, and more.
And unfortunately, Ben Franklin’s quote about nothing being certain except death and taxes comes with a caveat – while we know taxes will be due, we can’t always predict just how much they’ll be thanks in part to our country’s ever-changing tax laws.
A prime example of this is President Biden’s recent tax plan proposal, released in late April of this year. Let me just say, it isn’t kind to America’s upper crust. It suggests a number of perks and freebies for low- and middle-income Americans, such as guaranteed family and medical leave, free preschool and community college, limits on child-care costs, extended tax breaks, and more. But to pay for all the trillions and trillions of expenses, the Biden plan also includes a long list of tax increases for the wealthiest Americans . . . and, perhaps, some people who really aren’t rich.
While we don’t know yet which – if any – of the proposed tax increases will survive and be enacted into law, you’d be wise to understand the proposed plan now to prepare for the final law – which likely won’t take effect until 2022. So, this week with our time together, I’d like to dig into some of the key points of the Biden tax proposal to help you better understand if – or how – you might be affected.
For starters, the “Families Plan” could raise taxes on the rich. But even if you don’t consider yourself particularly wealthy, make sure you read closely to see if you might be caught up in any of the proposed tax hikes, since a few of them could rope some not-so-rich people in addition to the “one-percenters”.
The top marginal tax rate would go up to 39.6 percent, from 37 percent. While marginal rates are calculated on income bands, President Biden’s proposal would raise taxes not just on people currently subject to the highest rate of 37 percent. That rate currently starts when someone earns more than $518,000 or a couple earns more than $622,000. The 39.6 percent rate would start with people earning $400,000 a year. It could affect many people who are higher-earning who might not truly consider themselves wealthy. President Biden has said many times that he won’t raise taxes on anyone making less than $400,000 per year. But there still remain questions and a lack of clarity as to what this exactly means. For instance, does it apply to each individual or to each tax family? We still haven’t received a crystal-clear answer to that question. As a result, we’re not entirely sure if Biden wants to adjust the starting point for the top-rate bracket to account for his $400,000 threshold.
Another key consideration for investors is an increase to the capital gains tax. Under the Biden plan, anyone making more than $1 million per year will pay a 39.6% tax on long-term capital gains – folks, this is almost double the current top rate. The kicker here is that this is also the proposed top tax rate for ordinary income (e.g., wages). So, in effect, millionaires would completely lose the tax benefits of holding capital assets for more than one year. Plus, there’s the existing 3.8% surtax on net investment to help pay for Obamacare, which would bump the overall tax rate up to 43.4% for people with income exceeding $1 million. Add on state income tax and you are looking at giving those Washington Wizards about 50% of your gains . . . or more.
Next, there’s the proposal to eliminate the stepped-up basis on inherited property. Under current law, if you inherit stock, real estate, or some other capital asset, your basis in the property is increased (“stepped up”) to its fair market value on the date that the person who previously owned it died. This increase in basis also means you can immediately sell the inherited property and avoid paying capital gains tax, because there’s technically no gain to tax. Biden’s plan would change all this. Although details are scarce at this point, Biden’s plan as he has described, would essentially nullify the effects of stepped-up basis for gains of $1 million or more ($2 million or more for a married couple) – perhaps by taxing the property as if it were sold upon death.
Folks, this is a big one since this is one of the tax changes that could impact Americans making less than $400,000 per year – perhaps only indirectly. All Americans, regardless of their own income level, can inherit property. If the heir’s basis is not adjusted upward any longer, that in essence is a tax increase on all of us. If the capital gains tax is levied before the property is transferred, that could mean there’s less to inherit – which could be considered an indirect tax on the person receiving the property. It can be a bit tricky, but there’s certainly the potential for someone inheriting property who makes less than $400,000 per year getting the short end of the stick because of this Biden proposal.
Now, this is just a brief summary of a few potential changes coming our way. The full proposal includes a number of other adjustments that could also have a significant effect on the success of your retirement. You know, this all points to the crucial need to educate yourself on the proposal and take proactive measures to mitigate its effects. So, make sure to reach out to your retirement specialist and stay tuned, because you can trust that taxes will continue to be an important focus in my practice – and these columns – for the foreseeable future.
And as always – be vigilant and stay alert, because you deserve more!
Have a great week.
Jeff Cutter, CPA/PFS is President of Cutter Financial Group, LLC, an SEC Registered Investment Advisor with offices in Falmouth, Duxbury, & Mansfield. Jeff can be reached at firstname.lastname@example.org.
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