Is your financial plan ready for higher taxes?


You can smell it in the air – tax increases are coming. And it’s not a question of if, but a question of when. Over the past few months, there have been a number of legislative proposals targeted at high net worth and very high net worth taxpayers, ranging from Senator Bernie Sanders “For the law at 99.5%, ”By Senator Elizabeth Warren “Ultra-millionaire tax law“and Senator Chris Van Hollen”Fair Taxation and Fairness Promotion Act. “

While each proposal focuses on a different wealth segment and type of tax, the common theme and sentiment is that higher taxes may be on the horizon for the wealthy. If you are concerned about the possible changes ahead, what can you do now to plan for them?

Income tax

The two most discussed income tax proposals bring the top marginal tax rate to 39.6% (up from 37% currently) and the long-term capital gains rate (LTCG) to 39. , 6% (compared to 20% currently) for those with incomes over $ 1 million. Combined with the 3.8% net investment income tax, the LTCG could be taxed up to 43.4% at the federal level.

It is not clear whether these tax increases, if passed, would take effect from the next tax year, retroactively to the start of this year, or somewhere in between. Therefore, now may be the time to assess your portfolio, identify assets with built-in gains, and determine whether it is advisable to sell before rates rise. This would help lock in the current lower tax rates.

While no investment decision should ever be dictated by taxes alone, careful analysis of after-tax net return is essential to understanding the real value and cost of holding an investment for the long term versus sale in this environment. Likewise, any tax strategy that allows for income tax deferral should be given further consideration. Tax-advantaged accounts, such as IRAs, 401 (k), Health Savings Accounts (HSA), and 529 plans, offer enhanced benefits, as taxes on income earned on the assets in these accounts can be deferred and possibly eliminated if certain conditions are met.

Note that the IRS recently extended the income tax filing deadline to May 17, and with that, the IRA and HSA contribution deadline for the 2020 tax year. So it is again. time to maximize these tax-efficient vehicles. Additionally, those with a large IRA may consider a Roth IRA conversion when the “conversion tax” is relatively lower with the current income tax rate.

Inheritance tax

The current exemption from federal inheritance tax is a record high of $ 11.7 million. It is expected to end at the end of 2025, when it will drop to $ 5 million, indexed to inflation. Various proposals have been consistent enough to call for a decrease in the exemption to $ 3.5 million. High net worth individuals should take advantage of the current exemption to make large donations to trusts for their children and grandchildren.

While many understand the benefits of giving, many don’t take action because they don’t know how much to offer and what goods to offer. In general, assets with the potential for significant long-term capital gain but whose current valuation may be depressed due to the pandemic are the ideal assets to offer. An experienced financial planner can help you quantify the impact the donation has on your future income needs. In particular, a sustainability analysis should be conducted to determine how a gift that is withdrawn from your balance sheet will impact your future cash flow and lifestyle needs. The durability analysis may also be stress tested to account for any future eventualities.

Depending on your balance sheet and your needs, donating the maximum amount allowed by current law could be too big a gift and could start to erode your future cash flow needs. In this case, it may be a good idea to reverse engineer a more comfortable donation amount.

Do not forget your state of residence

While the focus has been on potential tax increases at the federal level, don’t forget about possible tax increases at the state level. Like the federal government, states are also looking for ways to increase their revenues to offset spending needs during the pandemic. For example, New York State recently increased its top tax rate to 10.9% (from 8.82%). If you’re a New York City resident, your combined federal, state, and local tax rate could be the highest in the country, followed closely by California.

While the above strategies to mitigate income tax would apply at the state level, an additional strategy to consider is to create a trust in a tax-advantaged jurisdiction, such as Delaware. For example, if properly structured, a person living in a high tax state can create a trust for the benefit of their children and grandchildren and locate (or locate) that trust in a low (or no) tax jurisdiction. If the trust is structured as a “non-grantor trust,” the trust will be treated as a separate taxpayer, in which case it may escape tax in the home state of the individual grantor and be subject only to the taxpayer. federal tax. This would effectively eliminate any state income tax on the sale of an asset and all future income and gains.

To put this strategy into context, applying today’s income tax rates and if properly structured, a New York City resident with a marketable securities portfolio with built-in LTCG of $ 1 million of dollars can save over $ 100,000 in New York State and city income tax using this type of strategy. There are certain restrictions and limitations to this strategy, and it is very specific to each state because different states have different rules on the taxation of trusts. Therefore, it might be essential to work with professionals familiar with trust and state taxation.

While no one has a crystal ball on what will happen with taxes, a savvy investor should consider planning now for what is likely to come. The window of opportunity might close soon, and you need to be prepared with a plan, so that when (not if) As tax laws change, you are ready to execute this plan on which may be very short notice.

Wilmington Trust is a registered service mark used in connection with various fiduciary and non-fiduciary services offered by certain subsidiaries of M&T Bank Corporation. M&T Emerald Advisory Services and Wilmington Trust Emerald Advisory Services are registered service marks and refer to that service provided by Wilmington Trust, NA, a member of the M&T family.
Please note that tax, estate, investment and financial strategies require consideration of the suitability of the individual, business or investor, and there can be no assurance that a strategy will be successful. . Wilmington Trust is unauthorized and does not provide legal, accounting or tax advice. The advice and recommendations provided to you are illustrative only and subject to the opinions and advice of your own lawyer, tax advisor or other professional advisor. Investing comes with risk and you can make a profit or a loss. There can be no assurance that an investment strategy will be successful.

Chief Wealth Management Strategist, Wilmington Trust

Alvina Lo is Head of Strategic Wealth Planning at Wilmington Trust, which is part of M&T Bank. Alvina’s previous experience includes positions with Citi Private Bank, Credit Suisse Private Wealth and as a practicing lawyer at Milbank, Tweed, Hadley & McCloy, LLC. She holds a BS in Civil Engineering from the University of Virginia and a JD from the University of Pennsylvania. She is a published author, frequent speaker, and has been cited in major media outlets such as “The New York Times”.


Louis R. Hancock