2. Increase taxes on capital gains and qualified dividends from 20% to 39.6%.
Raising many eyebrows is the proposed jump in the capital gains rate. Under President Biden’s plan, income from long-term capital gains and certain dividends would be taxed at the ordinary income rate of 39.6% for people earning more than $1 million. (It’s not clear if that threshold applies to individual taxpayers or per return.)
Additionally, the current net investment income surtax of 3.8% imposed on high-income taxpayers would be reworked to apply more consistently to taxpayers making more than $400,000 per year. That means, for some people, the new top federal tax rate on capital gains would total 43.4%.
3. Limit the “step-up” in basis at death on estate taxes.
The value of assets passed on to beneficiaries is usually higher than when the owner acquired it. Currently, the appreciation is not taxed, and beneficiaries get a step-up in basis. Under President Biden’s proposal, appreciation on assets in excess of $1 million per individual taxpayer/$2.5 million per couple would be taxed at death.
The proposal keeps the estate tax rate at 40% with an exemption amount adjusted for inflation, which is currently $11.7 million per taxpayer. However, the exemption is set to go back to its pre-2017 level of $5 million per taxpayer (adjusted for inflation) beginning in 2026. Family-owned farms and businesses passed down to family members who will continue to run the businesses are not included. And gains will not be taxed if the property is contributed to a charity.
It’s important to remember that this is only the opening round of policy negotiations between Congress and the White House. It’s difficult to predict what will happen—but the final bill is likely to be very different than what we see sketched out today. As always, we are closely watching developments and how they could impact our clients.
This is a good time to review your situation:
- Your estate plan: Even with exemptions, limiting the step-up in basis may change estate planning as you think about lessening the tax burden on heirs. Keep in mind, however, that determining the original cost basis for assets held for decades is also one of the more complicated tax code changes to implement.
Still, you may want to review your plans while you have time on your side. This includes looking at the different types of accounts you hold and their taxation as an inheritance.
- Your risk tolerance: Any talk about raising taxes may move the markets. For example, some investors may sell holdings at a profit in anticipation of tax increases to pay taxes at a lower rate.
It’s always wise to think through your long-term investment strategy and see if it’s still aligned with your time horizon and your willingness to accept short-term volatility.
- Your current investment strategy: Review how you’re directing your dollars today and how it could be affected by the potential of higher tax rates.
For instance, would more tax-efficient investments be beneficial? Or can retirement accounts and 529 education plans with tax-free withdrawal benefits play a bigger role? Also, Health Savings Account (HSA) owners have tax advantages when withdrawals are used to pay for qualified medical expenses.
We caution against making any drastic moves to your financial plan based on current headlines. There are professionals available to discuss your specific situation and potential needs.