American Families Plan: What’s the Potential Impact?
President Biden proposed the American Families Plan last month, which includes several proposed changes that, if passed into law, may have a significant impact on your wealth plan. While the proposal is still in the early stages, the changes being proposed are meaningful. We encourage you to review your wealth plan with your advisor.
In late April, President Biden proposed the American Families Plan (AFP), which may bring significant tax changes, including the elimination of the step-up in basis at death which could upend a widely used estate planning tool. While some components of the AFP have made their way into various bills in Congress, it’s important to note that we’re likely to see extensive negotiations and the final law may look quite different from what is proposed. Here are some of the key proposals of the AFP that we’re tracking.
Key Proposed Changes from the American Families Plan
Increased capital gains and dividend rates: For households with income of more than $1 million, the long-term capital gains and dividend rates would increase to 39.6% on these types of income (the top nominal tax rate is currently 20% for taxable income over $496,000 for those who are married filing jointly). Combine this with the 3.8% Net Investment Income Tax, some taxpayers may see a top federal rate of 43.4% on the realization of capital gains or receipt of dividends.
- What we might see: While increasing the top rate to 39.6% seems like a stretch (especially for capital gains), landing somewhere in the middle around 25% or 28% appears to be a more likely result.
Elimination of the step-up in basis at death: The step-up in basis would cease for gains above $1 million. Currently, when you pass away and you gift assets to your beneficiaries, these assets get a “step-up” in basis to the date of death fair market value. This means that the value of your assets is readjusted to reflect the fair market value of the assets at the time of death, effectively eliminating the tax on gains.
For example, if you have a piece of property worth $3 million at the time of your death and its cost basis is $50,000, the cost basis would be stepped up to the current value of $3 million. Your beneficiaries could sell the property with no recognition of gains. If you have assets that have a low-cost basis or assets that have appreciated significantly, currently it is better to have these assets pass to your beneficiaries after your death rather than gifting these assets during your lifetime.
- What we might see: The step-up in basis, if eliminated, would upend a widely used planning tool that’s been a cornerstone of estate planning for many families. The result would likely trigger an increase in lifetime gifting because there would no longer be a benefit to holding onto these assets until death. In fact, transferring assets during life may become more advantageous for some because all future growth would occur outside their estate. The desire to eliminate the step-up in basis is not new; however, removing it may be more challenging than it seems. It’s usually very difficult to determine the cost basis for assets that have been held for decades, not to mention tracking depreciation and add-backs.
Capital gain realization at death: The Sensible Taxation and Equity Promotion Act (STEP), a new Senate bill, would trigger the realization of long-term capital gains on lifetime transfers and at death. There would be an exception for the first $100,000 of gain for lifetime transfers and a death exclusion for the first $1 million of gain. There are exclusions for farms and closely-held businesses.
- What we might see: This may be worse than eliminating the step-up basis because it would force the realization of gains even if assets are not sold, but merely transferred. This would have a similar effect to the current estate tax by triggering tax even when there is no immediate liquidity. If this proposal passes, planning for liquidity for lifetime and death transfers will become a prime wealth planning objective.
Reduction of estate & gift tax exemption: The current proposal does not address a change to the estate tax exemption amount, although reducing the exemption was part of President Biden’s campaign. While this could provide significant relief for many, a bill introduced in the Senate – the 99.5% Act – proposes decreasing the gift tax to $1 million and the estate tax to $3.5 million.
- What we might see: Again, it’s important to note that this bill may not become law as it makes its way through Congress. For now, we can breathe a sigh of relief that the estate tax is not on the chopping block until 2026.
When Would These Changes Take Effect?
The proposals are silent on an effective date. While tax law changes are typically prospective, there’s significant talk about these changes being retroactive. A revision of the 2021 budget is possible, which means changes to the tax law could go into effect in 2021. Through reconciliation, this could include implementing both the American Rescue Plan and the American Families Plan through a simple majority vote, rather than requiring 60 votes (similar to how the Tax Cuts and Jobs Act was passed in late 2017). However, due to the significant impact of these tax law changes, it’s highly likely that negotiations will take some time, meaning we might not see clarity on this until later this year or even early next year.
Planning for Uncertainty
While these proposals are still in the early stages, the changes being proposed are significant and may have a meaningful impact on your wealth plan. We encourage you to review your wealth plan and consider some of these strategies now.
If There’s an Increase in Capital Gains
- Harvest your gains. Capital gains rates today are the lowest they have ever been. If capital gains rates are set to increase, it may be best to sell some “winners” to lock in a lower tax rate today. In the right circumstance, this could result in a lower tax bill and the opportunity to rebalance a portfolio into more tax-efficient investments.
- Tax-loss harvesting. Since the proposals target those with income over $1 million, initiating plans to keep income below $1 million will be key. Strategically capturing losses to offset future gains might help keep net income below the $1 million threshold.
- Charitable giving: Similarly, giving to charity can help drive down net income, keep you out of the top marginal tax bracket, and prevent the realization of gains. One strategy you may want to consider is to “bunch” your donations over multiple years, which would get you a greater tax benefit by boosting total itemized deductions in certain years.
- Capital gains bunching: Like the bunching strategy for charitable giving, this involves strategically selling your assets so that total net gain realized is close to but below the $1 million limit. This strategy could be facilitated year-over-year to minimize taxes and would help you avoid the higher income threshold.
- Hold assets longer: The tax code is constantly evolving. If you don’t intend to realize any significant gains in the coming years, you could wait to see what happens under a future administration. Of course, this is a big unknown, but deferring the realization of gains may be at least a partial strategy worth considering if it works out for your situation.
If There are Changes to the Step-Up Basis and Realization of Capital Gains at Death
If the step-up in basis is eliminated, gifting assets during your lifetime becomes much more appealing because it removes future growth from your estate. Consider the following options to create flexibility and add liquidity to your wealth plan:
- Flexible grantor trusts allow for maximum post-execution planning, such as swapping assets, borrowing, and loaning.
- Irrevocable trusts create flexibility for gifting to a charity.
- Spousal Lifetime Access Trusts allow spouses to irrevocably gift assets to each other, using the current low gift tax exemption amounts, while also giving each spouse indirect access to the assets through their spouse.
- Life insurance held in an irrevocable trust creates liquidity for paying taxes and is income tax-free at death, while also remaining outside an estate for tax purposes.
- Gifting low-basis assets to charity or within a Charitable Remainder Trust removes these assets from the estate and creates a tax deduction (that can be used to diversify from concentrated positions). The Charitable Remainder Trust also creates an income stream for life.
- Valuation discounts that leverage gifting above the estate tax exemption amount.
Remember, none of the proposals are law and any that become law will undoubtedly look different in its final form. We highly encourage you to speak to your advisor about these potential changes and how they may impact your wealth plan. Your advisor can account for these potential scenarios and implement recommended strategies, when and if they are needed.
Talk with a Local Advisor
Mercer Advisors is neither a law firm nor an accounting firm. Mercer Advisors does not provide legal advice to clients. All estate planning documentation preparation and other legal advice is provided through Advanced Services Law Group, Inc.
Mercer Advisors Inc. is the parent company of Mercer Global Advisors Inc. and is not involved with investment services. Mercer Global Advisors Inc. (“Mercer Advisors”) is registered as an investment advisor with the SEC. The firm only transacts business in states where it is properly registered or is excluded or exempted from registration requirements.
All expressions of opinion reflect the judgment of the author as of the date of publication and are subject to change. Some of the research and ratings shown in this presentation come from third parties that are not affiliated with Mercer Advisors. The information is believed to be accurate but is not guaranteed or warranted by Mercer Advisors. Content, research, tools and stock or option symbols are for educational and illustrative purposes only and do not imply a recommendation or solicitation to buy or sell a particular security or to engage in any particular investment strategy. For financial planning advice specific to your circumstances, talk to a qualified professional at Mercer Advisors.
Past performance may not be indicative of future results. Therefore, no current or prospective client should assume that the future performance of any specific investment, investment strategy or product made reference to directly or indirectly, will be profitable or equal to past performance levels. All investment strategies have the potential for profit or loss. Changes in investment strategies, contributions or withdrawals may materially alter the performance and results of your portfolio. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will either be suitable or profitable for a client’s investment portfolio. Historical performance results for investment indexes and/or categories, generally do not reflect the deduction of transaction and/or custodial charges or the deduction of an investment-management fee, the incurrence of which would have the effect of decreasing historical performance results. Economic factors, market conditions, and investment strategies will affect the performance of any portfolio and there are no assurances that it will match or outperform any particular benchmark.
This document may contain forward-looking statements including statements regarding our intent, belief or current expectations with respect to market conditions. Readers are cautioned not to place undue reliance on these forward-looking statements. While due care has been used in the preparation of forecast information, actual results may vary in a materially positive or negative manner. Forecasts and hypothetical examples are subject to uncertainty and contingencies outside Mercer Advisors’ control.
Certified Financial Planner Board of Standards, Inc. (CFP Board) owns the CFP® certification mark, the CERTIFIED FINANCIAL PLANNER™ certification mark, and the CFP® certification mark (with plaque design) logo in the United States, which it authorizes use of by individuals who successfully complete CFP Board’s initial and ongoing certification requirements.