The three takeaways in this article:

1. What you can expect regarding the Increase Capital Gains Rate
2. How Estate Planning & Gifting will change next year
3. How to use Tax Credits for parents and children

While I was out to lunch with Sue, a small business owner in the Event Planning space, she asked me about Biden’s proposed tax increases and if she should be doing anything about it. Given that Sue is nearing retirement and her business is very profitable it was important to discuss how the proposed budget would impact her and the business.  

Sue was hoping to work for 3-5 more years and then sell her business when she reaches 65 for Medicare purposes. While this is very much still an option, Sue and I decided to review her situation in more detail so she could make the most educated decision moving forward. Since selling a business and retiring is a massive decision in itself, if the new proposed tax law changes would help make her decision easier then it was my job to let her know. 

The Capital Gains Rate is expected to increase from 20% to 39.6% on income in excess of $1 million

Proposal: Increase the top capital gains rate (raising the capital gains tax is an alternative to raising the estate tax exemption) currently at 20% to 39.6% before application of the 3.8% net investment income tax for income in excess of $1 million (possibly retroactively – Yes, this can be done due to Article I, Section 9 of the United States Constitution)

Ex: In 1993, the top ordinary income tax rate was increased on both ordinary income as well as the estate and gift tax retroactively to the beginning of the year (even though it was enacted in August). 

What can Sue do: It may be worthwhile to accelerate the sale of her company in order to capture gains at today’s current top capital gain tax rate. Additionally, those that have appreciated land, real estate, stocks, collectibles, etc should look to do the same. 

Ex: Sue (60) owns a company that she is looking to sell in the next 3-5 years as she is nearing retirement. Her income is typically $300,000 and the value of her business is $3 million. If she sells her business this year she will pay 20% instead of 39.6% (plus the 3.8% medicare surtax) on any income above $1 million. So, $460,000 (20% x $2.3 mill) vs. $910,800 (39.6% x $2.3 mill). The difference being $450,800 which if you invested at a 6% rate of return over the next 30 years (Sue at age 90) would be $2.58 million dollars. 

Sue’s Options: Keep the business until she is ready to sell, sell the business now, or sell the business and consult the acquiring company for a set number of years for a lower sale price. 

Our Guidance: Sell the business and consult the new company. This will enable her to bridge the gap between now and Medicare when paying for health insurance out of pocket is extremely expensive, capitalize on a low capital gain tax rate, and provide her the peace of mind that her clients will be taken care of while she collects an income. 

Estate Planning & Gifting

• Death itself would become a capital gains realization event (1 million exemption)
• Gifting is now a realization event (so if you’re looking to gift an appreciated asset soon it may be worthwhile to accelerate that into this year) 

Ex: If you gift an asset that has a basis of $100k and it is now worth $1mill then $900k would be taxed immediately. Previously, the recipient of the gift would not realize a taxable event until the asset is sold. 

Tax Credits for Parents and their children are increasing

• Child and Dependent Care Tax Credit refundable credit up to 50% of up to $8,000 in expenses for one child/disabled dependent ($16k for more than one child/disabled dependent) with a phaseout and an exclusion of up to $10,500 in employer assistance/contributions for dependent care. 
• *Child Tax Credit extends the ARP child tax credit through 2025, including a maximum of $3,600 for children under 6 and $3,000 for children 6 through 17. Half of a taxpayer’s total allowable credit would be received as monthly advance payments and half would be paid when households file their taxes; any discrepancies would be reconciled on tax returns. Notably, by proposing that only half of the credit be paid out monthly, the resulting maximum monthly payments would be $150/$125 per child for 2022 through 2025, with the rest received at tax time, compared to maximum monthly payments of $300/$250 under the current ARP child tax credit in 2021. Full refundability, regardless of earned income, would become permanent.

*Source – Biden Proposed Child Tax Credit

Here are some additional facts and what you should know:

• The QBI (Qualified Business Income) deduction is here to stay – QBI Deduction – IRS
• 1031 exchanges, if you’re a married couple then Biden is proposing a 1 million per year cap on 1031 exchange exemption (500k for single filers) – 1031 Exchange – IRS
• Proposed 3.8% surtax to S-Corps distributions
• There have been talks about getting rid of  “Zeroed Out Grats” and rolling GRATs 

What should you be doing now? 

1. Think about your goals and objectives for your life, employment, gifting plans in order to prioritize the next steps
2. If your income is less than 1 million then proposed tax increases don’t affect you
3. Plan now and prepare while you have time. Planning on selling a business, piece of land, or real estate in December is not feasible.
4. Sit down with your tax professional and CERTIFIED FINANCIAL PLANNER™ to plan the next steps