By Richard Rubin and Rachel Louise Ensign
President Biden's American Families Plan would raise
capital-gains taxes and end a rule that has been a cornerstone of
estate planning for generations of wealthy Americans.
The change -- increasing the top capital-gains rate to 43.4%
from 23.8% and taxing assets as if sold when someone dies -- would
upend the tax strategies of the very richest households. Mr.
Biden's plan would also claw back some benefits Congress gave to
slightly less wealthy multimillionaires who have been spared from
the estate tax but now could face capital-gains taxes at death.
Today, people who own assets that have boomed in value -- Apple
Inc. stock, the family beach house, a three-generation
manufacturing company -- don't pay capital-gains taxes unless they
sell. Under the Biden proposal, those unrealized gains would
trigger taxes upon the owner's death, minus a $1 million per-person
exemption.
More than two-thirds of all U.S. families have some unrealized
capital gains, according to the Federal Reserve, but most would be
covered by the $1 million exemption. For families in the top 10%,
with a median net worth of $2.6 million, median unrealized gains
are $519,000.
The plan likely will change as it moves through Congress, and
some Senate Democrats are already balking. Rep. Cindy Axne (D.,
Iowa) is concerned about the impact on family-owned farms and is
working with other lawmakers from rural areas to seek an exemption
for them. Republicans say tax increases would kill jobs and slow
the economic recovery.
Meanwhile, wealthy people and their advisers are rethinking
strategies and investments. Financial adviser Ken Van Leeuwen says
he has received more fearful calls from clients about the tax-law
changes in the past week than ever. Even those who voted for Mr.
Biden are worried. "Are we becoming socialists?" he said one asked
him.
Mr. Van Leeuwen's Princeton, N.J.-based firm caters to people
with net worth between $5 million and $25 million. Many are
concerned their children will pay taxes on inherited second
homes.
The Biden proposal would blow up several longstanding tax
concepts: That capital gains deserve a lower tax rate than wages
and that people can inherit old assets without paying capital-gains
taxes. Democrats and their allies say those features of the tax
system, however, are unfairly tilted to the very wealthy.
"It's one of the biggest, most inefficient and
hardest-to-justify tax breaks that exists in the code," said
Chye-Ching Huang, executive director of New York University's Tax
Law Center. "There's just a tiny, tiny sliver of people that have
that kind of gain. It's just so unusual."
Under the current tax system, the top capital-gains tax rate is
23.8%, compared with 40.8% on wages, with state taxes on top of
both. Congress created the lower rate as an incentive to invest and
a way to prevent the tax code from discouraging asset sales. It is
also a rough adjustment for inflation.
Heirs have to pay such taxes only when they sell and only on the
gain since the prior owner's death. The provision is known as the
tax-free step-up in basis and has been part of the tax code since
the Revenue Act of 1921. It saves taxpayers more than $40 billion a
year, according to the congressional Joint Committee on Taxation;
the Biden proposal would take back some of that.
The step-up in basis is separate from the estate tax, which is
based on net worth at death, not just appreciated gains. It has an
$11.7 million per-person exemption. Opponents of Mr. Biden's plan
warn of steep combined rates on people hit by both taxes.
"If we lose the step-up in basis, that turns the estate planning
world upside down," said Alvina Lo, a tax attorney and chief wealth
strategist at M & T Bank Corp. unit Wilmington Trust.
The problem, Democrats say, is that significant amounts of
income escape the income tax entirely, because people can buy
assets, borrow against them for living expenses and die without
paying income taxes on the gain. For very wealthy investors or
billionaire founders of companies who take small salaries as their
stock grows, it can make the income tax effectively optional.
"If you're elderly and own highly appreciated assets, God forbid
you should sell them while you're alive," said Lawrence Zelenak, a
Duke University law professor.
Under the Biden plan, except for charitable bequests, death is
treated like a sale, with a $1 million per-person exemption. He
would keep existing exclusions for gain on a principal residence of
$250,000 for individuals and $500,000 for married couples.
Now, someone who paid $2 million for a business and dies when it
is worth $12 million would pay no capital-gains taxes. And if that
is his only asset, he would owe no estate taxes. Under the Biden
plan, he would pay taxes on $9 million -- the $10 million gain
minus the $1 million exemption -- with a top marginal tax rate of
43.4%. Assets held in retirement accounts generally aren't
affected.
The capital-gains rate change and taxation at death work
together. Without the change to the basis rules, the 43.4% tax rate
would lose money for the government because it would encourage
people to hold assets that they would otherwise sell.
The Biden proposal says it will have unspecified "protections"
so family-owned businesses and farms won't owe taxes if heirs
continue to run the business.
Manufacturers and farmers, who tend to be more asset-rich and
cash-poor, are watching closely for those details, concerned they
might have to sell illiquid businesses to pay the taxes.
Courtney Silver, president of Ketchie Inc., a family-owned,
25-employee machine shop in Concord, N.C. that started in 1947,
said she was concerned about the potential impact.
"I really can't imagine being hit with that decision of that
potential tax implication," said Ms. Silver, 40 years old, who took
over the business when her husband, Bobby Ketchie, died in 2014.
"That to me is really hard to wrap my head around."
It could be challenging for asset owners to figure out their tax
basis, which is what they paid for the property and invested in it.
That complexity is part of what doomed a similar proposal in the
late 1970s, which Congress passed, then delayed, then repealed.
Others might sell long-held assets to pay the taxes.
Vera Dunn lives in Beverly Hills, Calif., with her 102-year-old
mother in a house bought for about $100,000 in 1965. Ms. Dunn
estimates the house would be worth $10 million to a buyer who would
tear it down.
She said she has borrowed $4 million against the house to pay
for her mother's care and is already concerned about California tax
changes on inherited property. If her mother lives past the
effective date of the Biden plan, Ms. Dunn said, it would be
impossible to pay the taxes and keep the house.
"It happens to be a beautiful house in a beautiful location. It
happens to be all I have," she said. "Nobody's going to cry over my
situation. I'm not passing a handkerchief around, but everyone I
think can relate to [it.] How do you feel if you can't keep the
family home and if businesses are not paying taxes that are worth
billions of dollars?"
Wealthy Americans with over $100 million in assets are already
turning to a range of techniques to minimize the hit from steeper
taxes on their wealth, and many have already shifted further into
tax-advantaged assets, said Mike Kosnitzky, co-head of the private
wealth practice at law firm Pillsbury Winthrop Shaw Pittman
LLP.
The Biden proposal would make it be tougher for the merely
wealthy who use less sophisticated tax-planning vehicles to avoid a
hit, Mr. Kosnitzky said.
Jeremiah Barlow, head of family wealth services at Mercer
Advisors Inc., says his clients, who typically have a net worth
between $5 million and $15 million, are giving assets to loved ones
before they die to take advantage of the estate-and-gift tax
exemption.
Mr. Barlow is telling them they should be ready to accelerate
asset sales if the proposed changes take effect and to monitor the
effective date set by Congress. A family may want to sell its
business before the end of the year or sell stock that has
appreciated in value if they already planned to sell those assets
in the next few years regardless of tax-law changes.
Donating appreciated assets to charity could become an
increasingly appealing way of minimizing a tax bite, said Michael
Nathanson, chief executive of Boston financial advisory firm The
Colony Group. Such donations can bypass capital-gains taxes, and
the deductions from them can be used against other income.
One strategy to contend with the proposed tax-policy change tax
is to simply wait it out.
Republicans' opposition could make the tax change fragile. If
the plan were permanent, asset owners would face a roughly
tax-neutral choice -- pay taxes on a sale now or at death later.
But given the political landscape, the choice may be to sell now or
hang on until a future Congress changes the rules.
Investors' expectations are crucial for the policy change to
work as intended, said Jason Furman, who was a top adviser to
former President Barack Obama.
"If you think that it's going to be repealed by the next
Republican administration and the repeal is going to stand, then
you might still not realize your gains," he said. "It will take
some time to survive one regime change, to become an expected part
of the law."
Write to Richard Rubin at richard.rubin@wsj.com and Rachel
Louise Ensign at rachel.ensign@wsj.com
(END) Dow Jones Newswires
April 29, 2021 13:22 ET (17:22 GMT)
Copyright (c) 2021 Dow Jones & Company, Inc.
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