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Will Taxes Rise for the Wealthy?

The latest major initiative from the White House—a package of social measures known as the American Families Plan, comprising expanded child care assistance, two years of free community college, universal prekindergarten, and more—includes proposed tax increases on the wealthy to help fund the plan.

Among other things, the Biden administration’s proposal would:

  • Raise the top individual tax rate back to 39.6%—after previously being reduced to 37% by the Tax Cuts and Jobs Act of 2017.
  • Tax long-term capital gains and dividend income at ordinary income tax rates for individuals earning more than $1 million annually.
  • End the step-up in cost basis at death, which adjusts the cost basis of inherited assets to the fair market value at the time of inheritance when calculating capital gains taxes.

The plan also includes $80 billion for the IRS to help improve the tax-collecting process. (According to the Treasury Department, every dollar spent on tax enforcement by the IRS generates about $6 in revenue.) Such efforts are likely to affect the top 5% of taxpayers, including business owners, corporations, and the wealthy.

Of course, the president’s proposal is just that—a proposal. It will take an act of Congress to turn the White House’s proposed American Families Plan into legislation—and there’s a good chance that what emerges, if anything, will look very different from what the White House has initially outlined. That said, our view is:

  • The increase in the top individual tax rate has the broadest support among Democrats—and therefore the best chance of being approved.
  • Changes to the capital gains tax rate and basis step-up rule, which are not yet universally embraced by all Democrats on Capitol Hill, will be subject to considerable intraparty negotiations.

Importantly, we believe it’s unlikely that any tax increases passed in 2021 will be retroactive to the beginning of the year—meaning taxpayers will likely have time to consider what, if any, strategies are appropriate for their situation prior to any new rules going into effect.

Planning for transactions that could result in large capital gains, in particular, could become more important than ever for wealthier households. While we generally recommend a wait-and-see attitude, here are two ways those concerned about possible changes could potentially mitigate their impact should this become law:

  1. Tax-gain harvesting: Investors often focus on selling losing investments and hanging on to winning ones. However, from a tax-planning perspective, it might be preferable to sell a winner now to lock in a lower tax rate. Realizing at least a portion of your capital gains before any new laws go into effect could help you avoid a higher tax bill and create an opportunity to rebalance your portfolio back to its target allocation.
  2. Tax-loss harvesting: Investors can realize a loss on one investment to offset a gain on another. Should current capital gains tax rates rise for individuals earning more than $1 million annually, recognized losses could bring your net income to just below the $1 million mark—so long as you don’t run afoul of the IRS’ wash-sale rule, which disallows the loss if you purchase the same or a “substantially identical” security within 30 days before or after the sale date.

Because the changes to inherited assets seem far less certain, it’s probably too soon to make any major adjustments to your estate plan. Even so, if you’re concerned about what the potential changes could mean for your estate, your financial planner or estate-planning attorney can help you think through your options.

The bottom line

Taxes affect almost every aspect of investing and planning, but they shouldn’t take priority over your broader goals and risk tolerance. Before implementing any tax-planning strategies, we recommend meeting with professionals who can help you thoroughly analyze your particular situation.

What You Can Do Next

In his WashingtonWise for Investors podcast, host Mike Townsend focuses a nonpartisan eye on how policy can affect everything from the taxes we pay to how our portfolios may perform. Listen now.

Important Disclosures:

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness, or reliability cannot be guaranteed.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

The policy analysis provided by Charles Schwab & Co., Inc., does not constitute and should not be interpreted as an endorsement of any political party.

This information does not constitute and is not intended to be a substitute for specific individualized tax, legal, or investment planning advice. Where specific advice is necessary or appropriate, Schwab recommends consultation with a qualified tax advisor, CPA, financial planner, or investment manager.

The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.

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