The ultra-rich fear Biden will fill their favorite tax loopholes
The rich shouldn’t be too afraid of Joe Biden’s tax plans. It’s the really rich who should get nervous.
The president is expected to unveil a tax package on Wednesday that promises to increase the incomes of those who earn $ 400,000 or more per year. But executives and professionals who earn more than $ 500,000 a year already pay relatively high tax rates.
What potentially has much bigger ramifications is that Biden and Democrats in Congress are threatening to target a much richer group – the growing number of Americans with fortunes starting in the tens of millions of dollars – who often pay off lower tax rates than many middle-class families. .
Biden, along with Bernie Sanders and other members of Congress, have launched plans to end a long list of sometimes obscure deductions, exclusions and loopholes that are the favorites of the 0.1%. If some of this passes, it will transform the way the very rich manage their portfolios and pass their assets on to future generations.
“The most dramatic pieces are harder to understand and the ones most people haven’t heard of,” said Laura Zwicker, president of the private client services group at the law firm Greenberg Glusker in Los Angeles. . “I’m afraid that’s what’s going to sneak into the tax bills. These really change the landscape of the type of planning that can be done. “
The details of those rules may matter far more than the top marginal tax rate that Congress will ultimately agree on.
“When you focus on the rate, you often forget that what the rich pay is actually much less,” said Chuck Marr, senior director of federal tax policy at the Left Center on Budget and Policy Priorities.
TYPES OF RICH TAXPAYERS
The current rules essentially create two types of wealthy taxpayers, according to John Mezzanotte, managing partner of Marcum’s office in Greenwich, Connecticut.
One group is made up of generally well-paid professionals and executives – who have relatively few means to avoid the top 37% regular income tax rate on their earnings. For those who live in states like California and New York, the overall marginal rates hover around 50%. Some of them could see their taxes increase next year, especially if the top rate drops from 37% to 39.6% during Obama’s time, as Biden previously proposed.
But the pain could be offset for some by ending the $ 10,000 limit on state and local tax deductions, or SALT, imposed by the Republican tax law of 2017. Many Democrats are pushing to end the SALT limit despite the concerns of progressives that it would mainly benefit the rich.
Then there’s the second group – many of Mezzanotte’s wealthier clients – who don’t pay these high tax rates. This is because they do not primarily earn money from their work. Instead, they live on investments and therefore have to pay the lowest rate on capital gains and dividends of 23.8%. For a typical client like this, the effective federal tax rate can be 20% to 22%, he said, and some – especially those who own real estate – may pay even less.
Biden predicts a dramatic hike in the capital gains rate, bringing it down to regular tax levels for those earning $ 1 million or more. It may simply discourage the wealthy from selling their winning investments, although the president and other Democrats have made various proposals that make capital gains taxes harder to avoid.
One idea is to end a rule called “step-up in base”, which allows you to erase any taxable gain on assets at the time of death. For years, Biden has denounced the obscure rule, pointing out that it allows the wealthy and their heirs to avoid taxes altogether.
Ending a strengthened base would transform the way the very rich manage their portfolios. Advisors now generally encourage clients to hold onto their most valued assets for as long as possible in order to profit from the rule. Requiring heirs to pay capital gains “would change everything we do in the planning world,” said Brad Dillon, senior strategist at UBS. “It would completely change the planning calculation.”
Campaigning for president, Biden was less specific about plans for estates and gift taxes. The 40% levy can be easily avoided through various trust strategies. “They made Swiss cheese from this tax,” Marr said. Its reform has long been a priority for Democrats.
A bill proposed by Senator Sanders of Vermont would close most of these loopholes. For example, this would place a time limit on dynasty trusts, vehicles designed with no expiration date that are used to pass on fortunes not only to children and grandchildren, but to future unborn generations as well.
CAN TAX AVOIDANCE METHODS SURVIVE?
Even though Biden does not approve of Sanders’ entire bill, advisers to the wealthy fear lawmakers may slip some of these proposals into final legislation. The effect would be to undo or complicate decades of planning by America’s wealthiest families.
“A ‘revolution’ is not too powerful a word” for some of the ideas being discussed, said Edward Renn, partner at Withers. “I don’t think it will be possible for high net worth investors to escape these tax hikes unless they engage in sophisticated planning.”
The question is how many methods of tax evasion can survive Biden’s tax bill if it becomes law. Certain strategies already discussed by advisers, such as those concerning life insurance, could also be targeted in a final bill.
As big changes loom, wealthy Americans are trying to take advantage of the current rules by transferring money now. For example, advisors and clients plan to sell assets with big gains in 2021, in order to avoid a higher tax rate later.
THE RICH SCRAMBLE
Plus, at least for now, taxpayers can still use trust strategies and they are allowed to transfer an unprecedented amount of money, over $ 23 million for married couples, to heirs without triggering tax. on inheritances and donations.
“People are scrambling to get assets from their domains now,” Mezzanotte said.
Some families are rushed into quick decisions about transferring wealth, sometimes to very young children, said Josh Baron, co-founder and partner of BanyanGlobal.
“You have these estate planning considerations that are very immediate,” he says. “But they also have these non-financial implications on family dynamics, to make sure the next generation doesn’t feel entitled.”
Making those investment and legal decisions more difficult is the uncertainty of what ends up in Biden’s final legislation – if passed.
Another open question is when the new rules will be implemented. Most assume that a tax law will not be retroactive to the start of the year, but the rules could come into force at any time in 2021, including when the legislation is proposed or when it is enacted. . Or lawmakers could make changes effective in early 2022.
“We might have all year to do it – and we might not do it,” said Beth Kaufman, tax attorney at Caplin & Drysdale in Washington, DC With so much uncertainty and so many ideas swirling, ” it is a bit difficult to know what direction to go at the moment.
[More: Biden tax proposal draws ire from financial advisers]