Tax laws

Focus on Strategy: Preparing for New Tax Laws


The winds of political change bring with them the potential for significant tax code revisions. As expected, in late April, President Joe Biden unveiled a number of significant proposed changes to individual tax provisions. As with the proposed revisions to the corporate code made several weeks earlier, these potential increases would fund an ambitious multibillion-dollar “Build Back Better” spending plan.

To be clear, the ultimate forms these proposals take and their political paths remain uncertain. We believe, however, that it is likely that some changes will be enacted.

A mantra at Northern Trust is: “Better to plan than plan. Below, we discuss four areas of individual tax policy, how the proposals might shape the law, and corresponding strategies to consider. Note that many of these strategies are beneficial in all tax environments and are worth considering in wealth management plans no matter what.

Personal income taxes

Proposed change: President Biden has advocated raising the highest ordinary personal income tax rate from 37% to 39.6% for people earning more than $ 400,000 per year. With current rates at historic lows, this relatively small increase would represent a return to 2013-2017 levels.

Strategies to consider: If income tax rates are positioned to increase, we recommend identify areas to accelerate short-term income in order to take advantage of low rates and to defer expenses and losses. For example, those who control their compensation may decide to receive a bonus this year rather than the following year, or plan to exercise unqualified in-the-money stock options that expire. This analysis requires a detailed examination of current and future tax brackets.

Besides, reconsider whether you should make a choice to defer the remuneration to 2021, deferral of income tax on sums deferred until the date of distribution. We advise clients to keep in mind that (a) higher tax rates in the near future make choices to defer a less attractive option if funds will be needed for short-term goals; (b) their business plan is essentially an unsecured obligation; and (c) those planning to relocate will need to have state-specific rules regarding the taxation of distributions.

Finally, we recommend customers to consider Roth conversions as part of an overall tax diversification strategy. For example, clients can coordinate taxable and non-taxable withdrawals to minimize retirement income taxes by holding traditional and Roth individual retirement accounts.

Long-term capital gains and eligible dividends

Proposed change: Biden’s tax plan calls for almost doubling the rate of capital gains for those earning more than $ 1 million, from a maximum rate of 20% (plus 3.8% of income tax from net investment) at 39.6% (plus 3.8% tax on net investment income). However, we believe that an increase in the order of 25-30% is more likely, as investor ‘foreclosure’ (indefinitely postponing the sale of assets) is a risk that increases in proportion to tax, resulting in lower returns from tax revenues generated at the higher rates.

Strategies to consider: Even an increase to 25% would be an impacting tax change for many. Yet we continue to educate our clients that funding long-term goals, not taxes, should be the primary driver of decisions. Evaluating the impact of capital gains requires careful analysis and projection of future income and tax brackets: for example, there may be years in the future when a client’s income falls below the proposed threshold of $ 1 million, resulting in a lower rate.

Notably, if capital gains tax rates increase as proposed, our research suggests that the returns will be significantly lower for taxable accounts.

Realize capital gains when needed to fund goals and manage risk. Consider realizing capital gains (i.e. to ‘increase the cost’ of the tax base) at current low rates if necessary to fund short- and medium-term goals (which Northern Trust defines as 1 in 10 years). For longer-term goals, the “overcost” advantage wears off and investors may choose to keep the option in the event that future tax reform reduces the capital gains tax rate.

Use asset location strategies by placing tax inefficient assets in tax-deferred or non-taxable accounts. Interest income, dividend income and realized capital gains are not taxed in IRAs. Therefore, high yield and taxable bonds, real estate investment trusts (REITs), high dividend strategies and all active high turnover strategies should be in tax deferred accounts. We also recommend that you consider the use of installment sales to regulate annual income levels, maintain income below $ 1 million as much as possible, and gift of highly valued securities to a charity or donor-advised fund to fully avoid capital gains tax.

Base increase at death

Proposed change: Under current law, the cost base of assets is “raised” to fair market value on the date of death, which resets the tax base to fair market value and reduces capital gains taxes owed. President Biden has proposed removing the increase, and legislation to this effect has also been introduced in the Senate. The STEP law would impose unrealized capital gains on any transfer during life or upon death. On death, there would be an exclusion of $ 1 million and, during his lifetime, any donation to a person or to a trust other than a spouse would exempt the first $ 100,000 of cumulative gain from tax.

Strategies to consider: The long-term implications of enacting legislation that changes the base increase have the potential to have a significant impact on tax and estate planning.

Potential strategies to discuss with your advisors include flexible transferor trusts, which allow maximum post-execution planning options (asset swap, borrowing, lending), as grantors would need flexible documents to deal with the possibility of changing tax laws. Irrevocable trusts allow strategic donations to charities to avoid a deemed sale (and the taxation of capital gains) in conjunction with a prudent harvest of tax losses. To consider settling trusts when allowed for adaptability, as trusts prepared five or 10 years ago may experience tax issues that their drafters did not fully anticipate.

Changes to inheritance and gift tax

Proposed changes: Although President Biden did not address donation and inheritance taxes As part of the American Families Plan, potential changes to these laws continue to be a major concern for clients. During the election campaign, the president called for the return of inheritance and gift taxes to 2009 levels, indicating a proposal to reduce the current record exemption from $ 11.7 million to $ 3.5 million and higher inheritance taxes. Even though there are no changes to inheritance taxes, under current law, today’s record exemption will be halved by the end of 2025.

In addition, the “99.5% law” introduced by Senator Bernie Sanders would curtail several tax reduction strategies, many of which were also targeted under the Obama administration. These include (a) requiring that annuity trusts kept by the grantor (FREE) have both a minimum term and a residual interest; (b) limit valuation discounts for transfers of “non-business assets”, such as family limited partnerships; and (c) limit the annual exclusion of tax-free gifts that are often used to fund life insurance trusts.

Strategies to consider: The regulations for these proposals are already written and could be relatively easy to pass if they are seen as ‘plugs of loopholes’. Consider using today’s FREE and favorable valuation rules to reduce the value of gift tax and make the most of the expiring exemption. Today’s Libres rates remain historically low, so now is the perfect time to create a FREE. Consider funding trusts now, especially those that are expected to need cash to meet future expenses, such as life insurance premiums, in case annual exclusions are capped.

We also advise customers to consider give a gift to flexible trust structures whether the donation matches the client’s goals. This allows you to take advantage of today’s larger exemption before much of it potentially disappears. We recommend that you carefully examine your estate plan, in close collaboration with your advisers, in order to understand the possible legal and tax implications of your situation.

This column does not necessarily reflect the opinion of the Bureau of National Affairs, Inc. or its owners.

Author Info

Pam Lucina is Director of Trustees and Head of Trust and Advisory Practice for Northern Trust Wealth Management. Pam leads a national team of trust and estate professionals to help clients achieve their goals through the use of world-class tools and techniques, considering the human element of wealth and dynamics family. She is a recognized leader and speaker in the trust and estate legal community and a member of the American College of Trust and Estate Counsel (ACTEC).

Bloomberg Tax Insights articles are written by seasoned practitioners, academics, and policy experts who discuss current tax developments and issues. To contribute, please contact us at [email protected].


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