For wealthy Americans worried about higher taxes, the future is looking bleaker.
It’s all but inevitable that the Biden administration, as well as lawmakers at the state level, will target millionaires and billionaires for more levies. The new reality could feel harsh for investors who got used to paying a top rate of 23.8 percent on their capital gains, an amount they can lower further with many of the deductions, incentives and accounting tricks offered by the U.S. Tax Code.
Advisers, of course, will certainly try to help their clients adapt to whatever the new rules may be.
“We’re not going to evade taxes, but we’re going to avoid them and defer them as much as we can,” Bill Schwartz, managing director at Wealthspire Advisors, said in an interview. “We’re only beginning to explore. Give us a year or two and we’ll find ways around things.”
Wealthy Americans were amply warned that President Biden and Democrats in Congress want to raise their taxes. But what has surprised at least some of them is the size and speed of proposals.
On Thursday, Bloomberg reported that Biden plans to nearly
Some members of the top 0.1 percent expressed anger, denial and grief. The stock market, which has steadily risen since Biden won the election, reacted with dismay, with U.S. equities falling the most in five weeks on Thursday.
“Obviously, this is eye popping,” John Norris, chief economist at Oakworth Capital Bank, said in a note sent to clients. He calmed clients with the suggestion that “it likely won’t come to pass, at least at these levels,” adding: “Remember, elected officials on both sides of the aisle have wealthy donors who probably won’t like this very much.”
Epic shift
Biden is signaling an epic shift in tax policy: For more than a generation, presidents and Congresses have rolled out the red carpet for investors. When not cutting taxes on capital gains and dividends, lawmakers introduced incentives designed to encourage investment in targeted areas.
They were following both campaign contributors and economic orthodoxy, which insisted that low taxes encourages the sort of investment that boosts economic growth. But then a new generation of economists pointed out that the real-world evidence for those theories was flimsy.
Tax cuts don’t seem to have juiced economic growth in the U.S. over the last few decades, even as they coincided with soaring income and wealth inequality. Incentives programs — such as Opportunity Zones, a bipartisan idea to steer money to low-income areas implemented by President Donald Trump — have been criticized for
“Nobody has a crystal ball,” James Bertles, managing director at Tiedemann Advisors in Palm Beach, Florida, said in an interview. However, after the federal government spent trillions of dollars on COVID-19 relief, “most people think taxes are going to go up — it’s inevitable. We just don’t know which taxes are going to go up.”
If Biden is successful, Wall Street and investors who make most of their money from capital gains may need to get used to the idea that their taxes will look more like those of wealthy professionals such as doctors, lawyers, entertainers and even investment bankers who currently face marginal income tax rates north of 50 percent in high-tax states.
“Nothing is going to surprise us at this point,” said Tara Thompson Popernik, director of research for Bernstein Private Wealth Management’s wealth planning and analysis group. “We’ve been telling our clients for some time that this is likely coming.”
Tax strategies
Strategies to avoid a higher capital gains rate will depend on the details of the proposal, and on what other provisions get changed. An obvious technique, Schwartz and other advisers said, would be to keep incomes under $1 million — or whatever threshold is in the final legislation.
Investors might also avoid the higher rate by holding onto assets for as long as possible. That strategy, however, could be complicated by other provisions that Biden and Democrats have floated, like beefing up the estate tax and ending a rule, called step-up-in-basis, that allows asset-holders to wipe away capital gains taxes at death.
Life insurance products could also be a way for investors to cut investment taxes, as long as Democrats don’t target those strategies as well.
Alternatively, investors and business owners could rush to sell assets now, or before the end of the year — assuming tax changes aren’t made retroactive to the beginning of the year — to lock in lower rates. Advisers said they’ve been discussing sales of art and family businesses, along with highly appreciated stock, by year-end.
“If you’re going to do it anyway, maybe do it now,” Bernstein’s Thompson Popernik said. “The worry is that in the fourth quarter everyone else is going to be trying to make those changes at the same time.”
Thursday’s drop in the market prompted worries that, as Biden’s plans solidify and Congress starts to take action, stocks could continue to sell off. But it might not work that way.
“I would tell people to temper their fear of a significant drop-off in the markets,” said Bob Schneider, director of financial planning at Johnson Financial Group. Historically, markets have often risen even while taxes are going up, he said.
Indeed, stocks climbed on Friday after strong economic data.
Also, what else are investors going to do with their money? Especially at a time when the economy seems to be bouncing back from the pandemic, many investors want exposure to stocks.
“Yields are very low, so there aren’t a whole lot of other options,” Schneider said. “People will realize their gains and probably turn right back around and put their money back in the market.”
