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To pay for a historic and sweeping expansion of the social safety net, President Joe Biden and the Democrats plan to slap wealthy Americans with higher taxes.
In response, financial advisers and their affluent clients are also intriguing. Specifically, they’re looking at steps they can take now to avoid some of those higher levies down the road.
Some of the tax code changes that may soon be on the horizon include: A new 3% surtax on those earning more than $ 5 million; an increase in the top marginal tax rate to 39.6%, from 37% for people with household income over $ 450,000 and for people earning over $ 400,000; and an increase in the capital gains rate, which applies to assets such as stocks and real estate, from 20% to 25%.
Advisors say many clients breathe a sigh of relief at the latest proposals. Biden called for raising capital gains rate to 39.6%.
Yet many fear a higher tax bill.
âOur customers are worried,â said Michael nathanson, CEO and President of The Colony Group, a Boston-based consulting firm that works with high net worth individuals. “It would be one of the biggest tax increases in history.”
Here are some of the actions these concerns are prompting.
Nathanson recommends that some clients try to accelerate their income this year before higher rates go into effect.
If an individual sells a business, for example, they could try to close the deal by the end of the year, Nathanson said. Those who receive large bonuses at their workplace may try to negotiate a way to receive the money before 2022.
Normally, he would also try to maximize future deductions to bypass the new 3% levy for clients with income over $ 5 million, but that won’t work in this case as tax will be based on gross income. adjusted rather than taxable. Income.
âAdjusted gross income is calculated before itemized deductions are taken into account, so current deductions such as charitable contributions and mortgage interest would have no effect on the new surtax as proposed,â he said. -he declares.
To prevent customers from being hit with a higher marginal income tax rate next year, Mallon FitzPatrick, managing director and director of Robertson Stephens in San Francisco, advises them to consider donating an income-producing asset like real estate to a family member who is in a lower bracket.
âThe donor reduces taxable income and the recipient pays a lower tax rate on the income from the asset,â said FitzPatrick, a certified financial planner who works with clients whose net worth is $ 10 million or more.
Another way to report lower taxable income next year would be to delay some of your charitable donations – and the deductions they earn you – until 2022, FitzPatrick said.
“Charitable income tax deductions have more value in an environment of higher income tax rates,” he added.
The wealthiest people are limited in their preparation for what will likely be a higher rate of capital gains in the future.
That’s because policymakers have proposed to make the hike retroactive to September 13 of this year.
Still, investors have options, experts say.
FitzPatrick said individuals can defer their capital losses until next year, which would offset their gains when the tax rate could be 25% instead of the current long-term rate of 20%. (If your winnings are $ 10,000, but you have lost $ 5,000, your net win is only $ 5,000.)
âNext year, all of my capital gains could be subject to a 25% cap rate,â FitzPatrick said. “So my losses, which I can make up with my winnings, have more value next year.”
Lawmakers are also proposing to reduce the exclusion of estates and lifelong gifts to about $ 6 million from the current amount. $ 11.7 million, which means that more people will be affected by inheritance tax of up to 40%.
As a result, advisers say they are telling clients who are considering Lifetime Wealth Transfers to do so before the end of 2021.
This can be done in a number of ways, FitzPatrick said.
You can give the gift directly, which means you cede control of the assets to the recipient. The other option is to use a irrevocable trust.
With some trusts, you also give up power over assets – and therefore inheritance tax – but you can still set controls over how funds are distributed, FitzPatrick said. For example, maybe you don’t want a child to be able to earn an income from it until they turn 25.
âThis helps guard against the rapid exhaustion of confidence,â said FitzPatrick. âAfter the original beneficiary dies, their children become beneficiaries and so on. [It] preserves wealth for future generations.