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Daniel F. Rahill, LL.M, CPA, J.D.
Managing Director
Wintrust Wealth Management

With inauguration day less than six months away, the U.S. remains deep in the throes of economic fallout from preventative measures taken to combat the ongoing COVID-19 pandemic. Current tax rates for both individuals and corporations are at historically low levels, and higher taxes appear inevitable in order to pay for the trillions of dollars spent on COVID-19 relief measures. To that end, it is prudent for taxpayers to consider the potential implications of the proposed tax law changes of both presidential candidates and plan accordingly. Individual

Income Tax Rates
Presidential candidate Biden proposes an increase of the top tax rate from 37% to 39.6% for taxpayers with incomes above $400,000. The Biden plan would also remove the $10,000 cap on state and local tax deductions while limiting total itemized deductions for those in the 28% tax bracket and above.

President Trump proposes a 10% middle-class tax cut, lowering the 22% marginal tax rate to 15%. Trump also proposes to permanently extend the current lower individual rates and the higher basic standard deduction enacted by the TCJA that is scheduled to expire after 2025.

Implications: A lower-income-tax-rate environment is generally favorable for Roth IRA conversions to lock in lower tax rates on pretax retirement savings. Income acceleration strategies, such as capital gain harvesting, and deduction deferrals are also recommended options to consider should tax rates rise. Should the Biden plan go into effect, itemizers should plan to defer tax payments until after the law change.

Investment Income and Capital Gains
Under the Biden plan, the tax rate on long-term capital gains and dividends would increase from 20% to 39.6% for taxpayers with income above $1 million. Biden supports a financial transaction tax but has not released any details. Vice-presidential candidate Senator Harris has proposed imposing a financial transactions tax on stock trades at 0.2 percent, bond trades at 0.1 percent, and derivative transactions at 0.002 percent.

Trump has said that he is very seriously considering a capital gains tax cut through indexing capital gains for inflation. He has also proposed a capital gains tax holiday that eliminates capital gains taxes for a yet-to-be-identified period.

Implications: People with incomes over $1 million should consider selling appreciated assets prior to the elimination of the 20% preferential rate for long-term capital gains and qualified dividends. Gifting of appreciated assets to take advantage of the current increased estate and gift tax exemption, as well as charitable contributions of appreciated assets to qualified charities, donor advised funds and private foundations, can also be effective strategies to sidestep capital gains taxes.

The reinvestment of realized capital gains into qualified opportunity zone funds should be considered but also carries some risk. The benefits include the ability to defer a current capital gain to 2026, avoid 10% of that current capital gain if it is held for 5 years, and permanently avoid all future capital gains after the contribution if held for 10 years or more. However, the risk is that the current gain deferred to 2026 is subject to whatever capital tax rate is in effect in 2026, which may be higher than it is today.

Estate and Gift Taxes
The current estate tax exemption threshold is $11.58 million per individual (indexed for inflation) with a top tax rate of 40%. This amount is scheduled to revert to the pre-TCJA indexed amount of approximately $5.8 million after 2025. The Biden-Sanders Unity Task Force has recommended returning the estate tax regime to the historical norm. This could mean restoring the exemption threshold to the 2009 level of $3.5 million per individual, and it could portend an estate tax rate increase back to the 45% rate in effect in 2009, or higher.

Currently, a future capital gains tax is based on an assets value at the time it is inherited, referred to as the basis “step-up”. Biden’s proposal would eliminate this step-up for inherited assets. It is not clear if the proposal would provide the heirs with a carryover basis or impose capital gains tax on the decedent at the time of death. If heirs receive carryover basis, capital gains tax would be imposed on the heir based on the value of the asset from the time the original investment was made. Conversely, if the decedent’s estate pays tax on unrealized gains at death, the heirs likely would take the assets at a basis stepped-up to fair market value.

The Trump plan would extend the higher estate and gift tax exemption enacted by the TCJA that is scheduled to expire after 2025.

Implications: If Biden’s proposal takes effect, taxpayers with more than the full $11.58 exclusion amount should be planning gifts of their full exclusion amount now, before the exclusion amount reverts to a lower threshold. The Biden proposal to eliminate the inherited asset step-up in basis would also create significant practical problems in establishing the tax basis of long-held assets such as family businesses or farms, or investment assets for which the historical tax basis is no longer available. Taxpayers with significant appreciated assets should consider a wealth-transfer plan prior to enactment of such a proposal.

Which of these proposals become law depends not just on the election, but also on which party controls the Senate. Sweeping tax changes such as those proposed are not typically retroactive, but it is possible some tax increases could be retroactive to as soon as January 1, 2021.

It is critical for investors to consider these proposed law changes in their current investment and estate planning and be prepared to act quickly. If you have any questions on how this may impact you, please do not hesitate to contact your Wintrust Wealth Management professional.