New federal proposals could result in increased taxes. As the principal at Hongxin Wealth & Tax Planning Group in Bellevue, I spend much of my time advising my Chinese clients on the intricacies of U.S. tax laws and how any changes will impact them and their businesses.
These new tax proposals won’t apply only to foreigners and newcomers living on the Eastside. They will affect everyone. Here is a rundown of key changes we should all be aware of:
1. Increasing the highest long-term capital gains tax rate from 20 percent to 39.6 percent — President Biden proposes increasing the long-term capital gains rate to up to 39.6 percent for households earning $1 million and potentially making it effective retroactive to April 2021.
2. Increasing the highest income tax rate from 37 percent to 39.6 percent — Biden suggests increasing the top income tax rate to 39.6 percent for single taxpayers earning more than $452,700 and married joint filers earning more than $509,300 each year.
3. Lowering the lifetime estate and gift exemption from $11.7 million to $3.5 million — Estate and gift exemptions allow tax-free transfers to others either at death or during one’s lifetime. Not only would the individual exemption drop substantially, but the new tax proposal would also revoke the “step up” in tax basis an heir currently receives. A stepped-up basis means an heir benefits when inheriting appreciated property (stocks, bonds, real estate) upon the death of the previous owner by not having to pay capital gains taxes on the appreciation. Losing this benefit would significantly increase the tax liability on appreciated assets passed on to heirs.
Plan now for higher taxes
While the income tax proposals target taxpayers with gross income above approximately $450,000, the estate tax changes would impact more taxpayers and their children. Even moderately well-off families could see significant increases in estate taxes and related income taxes. Recently, the Tax Foundation estimated that combining all the increases could result in marginal tax rates as high as 61 percent. Therefore, now is the time to start planning for higher future taxes. Here is how.
- Sell now. If you plan to sell highly appreciated assets in the near future, consider selling now, in advance of potentially doubled capital gains tax rates.
- Defer gains long into the future. Consider deferring any real estate gains by reinvesting in the same type of asset by using Internal Revenue Code Section 1031 and a “like-kind” exchange. When you do a “1031 exchange,” you can defer paying capital gains when you sell one property and buy another. Through multiple exchanges, gains can be deferred far into the future to years when you potentially stop working and have a lower income.
Biden’s tax plan also could reduce the federal estate tax exemption from $11.7 million per person and $23.4 million per couple to $3.5 million per person and $7 million per couple. That, paired with the estate and gift tax exemption dropping significantly, means everyone should consider time-tested strategies that include:
- Setting up a life insurance trust to avoid estate taxes. Given the proposed $3.5 million individual estate tax exemption, anyone who owns one or two pieces of property in the Greater Seattle area — especially on the east side of Lake Washington — could face huge estate tax bills. An irrevocable life insurance trust, which is a trust that receives the proceeds of life insurance outside the estate and therefore is not subject to estate taxes, is a powerful tool to pay estate taxes that might be due with assets that are not included in the estate. Without a trust, the death benefit of life insurance is subject to estate taxes too, creating more tax liabilities and leaving fewer assets to pass on to beneficiaries.
- Using annual gift tax exclusions. Taxpayers can annually give up to $15,000 per person without incurring estate tax or income tax consequences. For example, in 2021, if a couple wanted to start giving assets to their children, each spouse could give up to $15,000 apiece to each child, therefore transferring considerable wealth to the next generation over time.
- Charitable trusts.
Anyone with significant assets should be aware of potential changes in U.S. tax laws and would be advised to consult a tax professional for ways to prepare for these anticipated changes.