For many Americans, the biggest consequences of the latest tax policies could be related to capital gains. The current highest capital gains rate possible, if you’re in California and over a certain income bracket, is 37.1%. Let’s take a quick look at the standard current rates, minus any state tax:
| Rate | Single income | Married filing jointly |
| 0% | Less than $40,000 | Less than $80,000 |
| 15% | $40,000 to $441,450 | $80,000 to $496,000 |
| 20% | More than $441,450 | More than $496,000 |
| +3.8% NIIT | More than $200,000 | More than $250,000 |
Under the American Families Plan, the goal is to keep the current rate schedule as well as the Net Investment Income Tax at 3.8%. What will possibly change is increasing the top rate to 39.6% for earners over $1,000,000. This means, the top federal rate would be 43.4% (and in California, an astronomical 56.7%, since the state has 13.3% rate).
The more capital a person has, the more necessary proper planning becomes. While we still don’t know a precise date — or even have 100% certainty that capital gains hikes will be enacted — it’s looking very probable something will happen and happen soon. High earners will be looking at nearly 44% capital gains rates in the near future. In order to save money, people should begin to turn to their accountants and tax professionals now to begin the tax planning process.
Here are five strategies to mitigate the expected capital gains tax rate increase:
1. Sell before effective date
The simplest strategy can be to accelerate the sale of the capital asset to trigger and lock in the lower tax rate. But when is the deadline to do this before the new higher rate kicks in? While it’s possible we’ll have short notice on the date of the enactment, it’s likely best to wait until the date is certain and the rate is known before making any big decisions. If rates go up, then there will likely be a frenzy at the end of the year to get assets sold before 2022.
2. Split ownership
To avoid meeting the $1,000,000 threshold, splitting ownership among different taxpayers, each of whom would be below $1,000,000, is another possible strategy. This could include children not subject to kiddie tax and separate taxpayers through non-grantor trusts.
For example, let’s say a person is planning a sale event of $2,000,000. For this hypothetical restructure to fall below the $1,000,000 threshold, the seller could split ownership through a revocable trust. The seller could retain $800,000 while $600,000 each could go to two beneficiaries through a sale or gift of equity. This would leave 40% ownership to the trustee and give 30% ownership to the two beneficiaries.
The tax without splitting the $2,000,000 would be 43.4%, which equals $868,000 of taxes due. Total tax with splitting would drop the rate down to 23.8% and only trigger $476,000 of taxes due. That’s a savings of $392,000 just by splitting ownership!
3. Move to tax-favorable jurisdictions
Often the best way to avoid tax is not to be subject to it. Sometimes it may be in the best interest of a person to move to a place with lower taxes. This is a big commitment, as it requires the person to become a resident of the low-tax state, while also making sure not to qualify as a resident of the prior state.
The IRS can look at the date a person moves and at evidence that the move will be permanent, such as the time of physical presence in the new state and the standard departure and return locations for trips. Evidence can also include involvement in local health and country clubs, religious institutions, and updated voter registration, passport and credit card addresses, among other things.
The only way to avoid being subject to both state and federal capital gains tax is to renounce citizenship. This involves an exit tax, but if done soon enough, it’s possible to renounce while the capital gains tax rate is lower. Sample countries with no capital gains tax include the Bahamas, Bermuda, Cayman Islands, St. Kitts and Nevis, the UAE and Singapore. If a person doesn’t want to renounce U.S. citizenship, another option would be to move to a U.S. territory that provides tax incentives such as Puerto Rico or the U.S. Virgin Islands instead.
4. Convert to 1202 stock
As of 2010, 100% of capital gains is tax exempt from the sale of 1202 qualified small-business stock, up to the greater of $10,000,000 or 10 times the adjusted basis. It requires a five-year hold, a non-corporate shareholder and must be original issuance in a company that was never an S corporation.
In addition, assets must be less than $50,000,000 and not be a qualified trade or business (no service, insurance, hotel, banking, farming, etc.). It requires a 1045 rollover if sold before five years.
5. Invest through tax-favored instruments
Investing in tax-free instruments such as private placement life insurance can be a great way to avoid tax. Structured properly, PPLI gives tax-free accumulation and tax-free access to appreciation via loans. There’s also an income tax-free death benefit and potentially estate tax-free death benefit.
A properly structured PPLI can be a great way to protect a portfolio. As an example, with an initial principal of $5,000,000 and an 8% average return, including the average annual cost of PPLI of 1.5% and a 45% federal and state tax rate, the numbers over 30 years can bring over $13,000,000 in tax savings:
| Years | Without PPLI | With PPLI |
| 1 | $5,220,000 | $5,319,000 |
| 2 | $6,201,153 | $6,811,926 |
| 3 | $7,690,861 | $9,280,467 |
| 4 | $11,829,870 | $17,225,416 |
| 5 | $18,196,378 | $31,971,983 |
