The fiscal stimulus train in Washington has continued to move forward. To date, Congress has passed several stimulus plans totaling an eye-popping $5 trillion to help mitigate the negative financial impact of the pandemic on Americans from coast to coast.
Largely financed through deficit spending, these packages have included the $2.2 trillion Coronavirus Aid, Relief, and Economic Security Act (CARES Act) in March 2020, the $900 billion Consolidated Appropriations Act in December 2020, and most recently, the $1.9 trillion American Rescue Plan in March 2021. With economic growth accelerating as the country reopens, it is fair to conclude that these stimulus measures have had their intended effect.
And, on the heel of passing the American Rescue Plan, the Biden administration has set its sights on fulfilling its campaign agenda of improving the nation’s physical and social infrastructure as announced in its $1.7 trillion American Jobs Plan (revised from $2.3 trillion) and $1.8 trillion American Families Plan.
In contrast to the previously passed stimulus measures, these proposed plans would be funded through higher taxes on U.S. corporations and high-income taxpayers. With higher potential taxes comes debate, and we expect Congress and the administration will be negotiating for the next several months. Sight lines are unclear as to which portions of each plan may garner support, but we expect markets and investors will be paying close attention. Of particular interest to us are some of the proposals in the American Families Plan, which target increases in taxes for high-income taxpayers.
American Families Plan Highlights
The White House released the American Families Plan at the end of April to further its goals of investing in children, families, and U.S. workers. The proposal includes $1 trillion in spending and $800 billion in tax cuts over a 10-year period.
Here are a few highlights on how the administration intends to pay for the plan:
Top Individual Income Tax Rate – Raise from 37 percent to 39.6 percent, thus restoring the top rate that was in place prior to the 2017 Tax Cuts and Jobs Act (TCJA).
Long-Term Capital Gains & Qualified Dividends – Tax capital gains and dividends as ordinary income for those with incomes over $1 million. The top tax rate would be 43.4% (including the 3.8% Medicare tax). Equalizing capital gains with ordinary income would end the carried interest spread.
Step-Up in Cost Basis at Death – Repeal the current step-up in cost basis for inherited assets with gains exceeding $1 million (or $2 million for couples). Certain protections would be created for family-owned businesses where the heirs will continue to operate those businesses.
Section 1031 Like-Kind Exchanges – Repeal tax deferment on real estate exchanges for gains greater than $500,000.
Additional IRS Funding – Provide $80 billion over 10 years for additional IRS enforcement of tax evasion, which the administration believes could net more than $700 billion in tax revenue over 10 years.
What Was Not Included
The American Families Plan did not include several notable items that taxpayers might have otherwise expected, though such items could be addressed in subsequent legislation:
Estate Exemption – Given prior statements to return the estate exemption to “historic norms,” many anticipated a push to lower the exemption to a range of $3.5 million to $5 million per person (from $11.7 million currently), with a top tax rate of 45 percent (from 40 percent currently).
Limit on Itemized Deductions – President Biden had previously called for limiting the benefit of itemized deductions to 28 percent for taxpayers earning more than $400,000.
State and Local Tax (SALT) Deduction – Many Democratic lawmakers have called for either an increase or a full repeal of the current $10,000 limit on the SALT itemized deduction.
By any measure, it is premature to draw conclusions about tax changes that may or may not happen in the coming months. However, it’s important for investors to monitor proposed changes with an eye on their long-term planning strategy.
In light of these proposals, here are the key things to keep in mind:
• Certain proposals are considered more likely to pass than others. Many tax practitioners think there is a good chance for a return of the top individual income tax return to 39.6 percent.
• Conversely, the proposal to overhaul the step-up in basis at death (a common fixture of estate planning since the Revenue Act of 1921) is considered controversial and could draw opposition from both sides of the aisle.
• As for the proposal to double the current tax rate on long-term capital gains and qualified dividends for certain high-income individuals, we think an increase from 20 percent to a range between 25 percent to 30 percent is a more possible outcome. If rates do go higher, tax gain and loss harvesting along with asset location strategies will be useful tools to help manage tax liabilities.
• As pandemic restrictions have eased, higher demand for goods and services is renewing prospects for inflation. From an optics perspective, adding more stimulus in an inflationary environment may be politically difficult.
• Don’t Overreact to the Unknown. While no one enjoys paying taxes, taxpayers should not embark on financial decisions that could jeopardize their financial game plan in the hopes of saving on future taxes.
• Engage Your Advisors. Taxpayers who might be impacted by the proposed changes should coordinate with their trusted team of advisors (accountant, estate planning attorney, investment advisor) to assess current or possible future planning opportunities.
• Maintain a Long-Term Perspective. Above all, investors should continue to make strategic decisions in a changing landscape based on the ability to compound wealth over time.
As always, if we can be helpful with financial planning or navigating the changing investment landscape, please reach out to us for assistance.