By: Andrew J. Willms
President and CEO of The Milwaukee Company
As we enter the countdown to the November election, the likelihood of a so-called “blue wave” (where Democrats capture the White House and both houses of Congress) appears to be growing. At least five of Wall Street’s market pundits are predicting a sweep for Joe Biden and his party, with Goldman Sachs putting the odds of the Democrats seizing control of the White House and Congress at 65%.
Should a blue wave in fact roll onto the shore, tax policy is likely to change. Democratic politicians have long argued that too much of America’s wealth rests in the hands of the nation’s moneyed class and the tax code is the party’s preferred tool for addressing the perceived injustice. The rules governing taxation of capital gains, in particular, have drawn the attention of many Democrats.
Capital gains taxes are imposed on the profits realized when a capital asset (such as stocks, bonds, real estate, etc.) is sold for more than it cost (referred to in tax parlance as “tax basis”). Currently, the tax rate on capital gains depends primarily on how long you own the asset that was sold. Gains on investments held for a year or less are treated as short-term capital gains, which get the same tax rate as ordinary income. Significantly lower rates apply to long term capital gains (gains on assets that were owned for more than a year).
Long-term capital gains tax rates for 2020 tax year
Former Vice President Biden has proposed that the tax-favored treatment presently afforded to long-term capital gains be eliminated for the very wealthy. Instead, he favors taxing their capital gains at the highest tax rate applicable to ordinary income. Today that is 37%, but under Biden’s tax plan that rate would rise to 39.6%.
Biden’s capital gains tax hike would only apply to taxpayers with incomes greater than $1 million. That amounts to about 1% of all taxpayers, but according to the Tax Policy Center, that 1% pays more than 75% of capital gains taxes paid by all American households.
Biden is also proposing a major change in how capital gains taxes are imposed at death. Currently, when a person dies and leaves property to an heir, the tax basis of that property is adjusted to its fair market value on the date of death. This basis “step-up” means that when the heir sells that property, only appreciation that occurs after the former owner’s death is subject to capital gains taxes. The basis adjustment at death also eliminates the tax normally imposed on the sale of assets that have been depreciated for income-tax purposes. This can be particularly beneficial to heirs who inherit real estate.
Vice President Biden is proposing that the basis step-up rules be repealed, and for death to become a taxable event. Under his plan, estates would be required to pay capital gains taxes on the unrealized gain of all assets a decedent owned, according to Howard Gleckman, senior fellow in the Urban-Brookings Tax Policy Center. The same would be true with respect to gifts, Gleckman said.
Note, too, that the capital gains tax imposed at death would be in addition to the estate tax. Biden would raise those too. Today, every person is entitled to a “lifetime exemption” that allows $11.58 million to be transferred free of gift or estate taxes. The Democratic presidential candidate wants to cut this amount in half.
Given the foregoing, many taxpayers are starting to wonder whether it might make sense to trigger capital gains prior to the end of the year. Here are my thoughts:
If your net income is less than $1 million but you believe the massive increase in federal spending, combined with Democratic control of government, could lead to greater capital gains taxes than candidate Biden has proposed, then it may be best to accelerate capital gain recognition before the expected rate hikes take effect.
Capital gains taxes may be less of a concern when deciding whether to adjust your investments by selling appreciated securities.
If you have an undesirable investment that you have resisted selling because you did not want to forgo a basis adjustment at death, you may want to reconsider that decision if Biden wins.
If your heirs are in a higher tax bracket than you, you may want to trigger capital gains taxes before you die.
As the foregoing makes clear (I hope), whether it makes sense to voluntarily trigger capital gains taxes before the end of the year that could otherwise be postponed depends greatly on your personal situation. As a result, it is imperative for you to first consult with your tax advisor before making a decision on what course to take. Please feel free to contact us if you would like our assistance with this analysis.
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 If an asset had lost value during the decedent’s lifetime, the heir’s basis is “stepped down” to its fair market value on the date of death.  You can find a discussion of my thoughts on the estate planning consequences of Biden’s tax plan Here.