How These Changes Could Impact Investors

2021 may have begun with uncertainty for investors due to continued stock market volatility and potential changes to the federal tax code. To effectively manage your portfolio during this time, conservative approaches may be in order as investors focus on preserving wealth. Changing COVID-19 legislation may also impact the stock market.

Adams Brown Wealth Consultants recently discussed proposed tax changes and how to assess what current market volatility could mean for your investment strategies in a webinar.

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Current Gift and Estate Tax Rules

There is currently a gift tax exemption of $11.7 million, meaning that you can gift to your family members or other individuals $11.7 million during your lifetime without paying gift tax on the transfer. This exemption also means that your estate can be worth up to $11.7 million and the entire estate can transfer to the next generation, family members, or other individuals, without estate tax implications. This rate is adjusted yearly for inflation.

The current exemption was created within the Tax Cuts and Jobs Act of 2018, which raised the exemption from around $5.6 million to the current $11.7 million exemption we see today. This exemption is valid until 2025 under the current tax law, and then it will reset back to pre-Tax Cut and Jobs Act exemptions with an adjustment for inflation.

Above are the current tax rates for anything over the $11.7 million exemption currently in place. As you can see, the first $10,000 will be taxed at 18%, then the next $10,000 at 20% until you get to the 40% rate. As shown, estate tax gets expensive very quickly once it’s taxable. Often, states have their own estate tax guidelines which should be taken into account.

Each year, any individual can give another individual up to $15,000 without having any type of reporting requirement. A gift over $15,000 must be reported on Form 709 Gift Tax Return. Gifts under $15,000 will not go against the $11.7 million exemption that was discussed above. However, gifts above the $15,000 limit will go against the exemption and lower your allowed estate exemption. This is where gifting strategies  play a significant part as you reduce estate size to lower tax implications.

There are some states that may not tax estates at all. Your home state, or where an individual lives for most of the year, determines how your estate is taxed.  For example, Kansas doesn’t have an estate tax.

Proposed Changes to Estate Guidelines

Though these have not passed, these proposed changes were presented during the election campaign and have garnered attention in President Biden’s first few months in office. The proposed changes include:

  • Elimination of step up in basis – Unlike current code, If someone inherits a piece of land originally purchased for $100,000, the basis would no longer change when they inherit it. When the piece of land is sold for $150,000, there would be a $50,000 gain instead of stepping up the basis to the fair market value of the asset when the individual who previously owned it passes away.
  • Taxing unrealized appreciation – Using the land example again, let’s say an individual purchases a piece of land for $100,000 that has increased to a $150,000 value at the time they pass away. As a result, the estate may be subject to paying tax on the $50,000 of unrealized appreciation regardless of whether the land is sold by the family. These changes will be targeting the transition of appreciating assets such as land, buildings, stocks, bitcoin and anything else that has a basis.
  • Higher tax rates – The administration has proposed shrinking down tax rates so you’ll see the 40% bracket on an estate sooner. There has been no set dollar amount for this proposed change yet but the administration is also considering lowering the exclusion rate from $11.7 million to about $5.8 million, and in future years could drop the rate even lower.

Often with a new administration, proposed tax changes take a year or more to pass through Congress. The tax law changes that passed in 2018 were passed much faster As of the date of this writing, the proposed tax changes listed above have not been proposed in the House or Senate and have only been discussed by the Finance Committee.

Corporate Tax Changes

The Biden administration has also discussed various changes for corporate taxes, including:

  • Increasing the corporate tax rate to 28% – currently, the corporate tax rate is 21%.
  • Minimum tax for companies with $100 million in book profits – the administration wants to ensure that larger corporations are paying their share in taxes and is looking into creating an ATM, or alternative minimum tax.
  • Tax credits for small businesses establishing retiring plans – this will encourage small business owners to help their employees save for retirement by providing credits to those providing 401(k) plans for their employees.

Again, these are only proposed changes that are expected to happen under the Biden administration, and none of these changes have been written into law yet.

Individual Tax Proposals

Though these are all predictions, there have been various proposals from the Biden administration as to what individual tax changes may be coming, including:

  • Individual tax rate changes from 37% to 39.6% – this change will only impact those making more than $400,000.
  • Taxing long-term capital gains and qualified dividends at ordinary income tax rates – this will be at the highest 39.6% bracket on income above $1 million.
  • Additional Social Security tax for individuals making more than $400,000 – This is currently at 12.4% and split with your employer.

Potential Impact on Investment Strategies

Bank of America has estimated that the Biden administration tax plan could reduce the S&P 500 earnings by as much as 7%. There is currently a flat tax on corporations, and raising tax rates could affect profits, corporate profitability, and add to market volatility. There is no way for anyone to predict when tax rates will change, but higher tax rates in 2022 or 2023 could put downward pressure on stocks. Looking back to 1987 and 2013, these are the only two times in history where there’s been a focus on raising taxation on long term capital gains. In both cases, the stock market had downward market pressure for 3-6 months and then recovered. There is reason to believe that the stock market could follow the same pattern.

Taxes for corporations are expected to increase which could mean lower corporate profit and a short-term downward pressure on the stock market. There is also a concern for raising taxation on capital gains and losing the step up in basis which could also put negative pressure on the stock market. However, looking at history as a guide and with current interest rates, it seems as if these downward changes in the market will be short-lived. Though it is impossible to predict exactly what the stock market will do, if you look at how it has historically performed, things will go back to normal.

If you’re near retirement and needing to have access to that money, you should discuss with your advisor because that money equities may not be appropriate in the near term to due to volatility. Discussions with your advisor will ensure that you’re in the right tax vehicle for your investment strategy, whether that be maxing out your brackets by taking in income or deferring more, tax planning should be included in your investment review.

Contact your AdamsBrown Wealth Management advisor for a discussion of your needs.

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