The best plans anticipate what’s to come, and right now it’s looking more and more likely that the future could hold higher taxes, especially for the wealthy. Here’s what might be on the horizon, and a look at some ideas to help prepare for it.

You can feel it in the air — tax increases are coming. And it’s not a matter of if, but a matter of when. In the last few months, there have been a number of legislative proposals targeted toward high-net worth and ultra-high-net-worth taxpayers, ranging from Sen. Bernie Sanders’s “For the 99.5% Act,” Sen. Elizabeth Warren’s “Ultra-Millionaire Tax Act” and Sen. Chris Van Hollen’s “Sensible Taxation and Equity Promotion Act.”

While each proposal focuses on a different wealth segment and type of tax, the common theme and sentiment is that higher taxes might be on the near horizon for the wealthy.  If you are concerned of the possible changes to come, what can you do now to plan for them? 

Income tax

The two most talked about income tax proposals are raising the highest marginal income tax rate to 39.6% (up from the current 37%) and increasing the long-term capital gains (LTCG) rate to 39.6% (up from the current 20%) for those with incomes exceeding $1 million. Combined with the net investment income tax of 3.8%, LTCG could be taxed as high as 43.4% on the federal level.

 It is unclear whether these tax increases, if passed, would be effective beginning next tax year, retroactive to the beginning of this year, or somewhere in between. Therefore, the time may be now to evaluate your portfolio, identify the assets with embedded gains, and determine whether it is advisable to sell before the rates increase.  This would help lock in the current lower tax rates. Advertisement

While no investment decision should ever be dictated solely by taxes, a careful analysis of net after-tax return is critical in understanding the true value and cost of holding a long-term investment versus a sale in this environment. Similarly, any tax strategies that allow for a deferral of income tax should be given an extra look.  Tax-advantaged accounts, such as IRAs, 401(k)s, health savings accounts (HSAs) and 529 plans, provide enhanced benefits as the taxes on the income earned on assets in these accounts can be deferred and possibly eliminated if certain conditions are met.

Note that the IRS recently extended the federal income tax filing deadline to May 17, and with that, so did the deadline to contribute to IRAs and HSAs for tax year 2020. So there is still time to maximize these tax-advantaged vehicles. In addition, those with sizable IRAs may want to consider a Roth IRA conversion while the “conversion tax” is relatively lower with today’s income tax rate.

Estate tax

The current individual federal estate tax exemption is at an all-time high of $11.7 million. This is scheduled to sunset at the end of 2025, when it will revert back to $5 million, as indexed for inflation. Various proposals have been fairly consistent in calling for a decrease in the exemption to $3.5 million. Ultra-high-net-worth individuals should take advantage of the current exemption to make significant gifts to trusts for children and grandchildren.

While many understand the inherent benefit of gifting, many do not act because they don’t know how much to gift and what assets to gift.  Generally speaking, assets with significant long-term appreciation potential but whose current valuation may be depressed due to the pandemic are the ideal assets for gifting.  An experienced financial planner can help you quantify the impact of the gift against your future income needs.  In particular, a sustainability analysis should be conducted to determine how a gift that’s removed from your balance sheet will impact your future cash flow and lifestyle needs. The sustainability analysis can also be stress-tested to account for any future contingencies.