The recent Treasury “Green Book” provides additional details to the Biden administration’s capital gains proposals and has important implications for loss-harvesting strategies.
The “Green Book” is a document that is released by the Treasury and contains the administration’s revenue proposals for the year. While not a formal legislative bill, the recently released Fiscal Year 2022 “Green Book”1 provides additional details regarding the capital gains proposals previously outlined in the “American Families Plan.”2
Presidential tax proposals rarely become law in their original form. However, should these proposed changes become law, we would expect the following impact on individual investors:
- The value of tax-loss harvesting (TLH) in a separately managed equity account may increase, remain unchanged, or decrease, depending on the investor’s circumstances.3
- Estate and gift dispositions would essentially be treated as liquidation events, which may decrease the value of TLH.4
- It may be too late for investors to benefit from accelerating gains or pausing TLH in the future.
Summary of Proposed Capital Gain Changes
The main “Green Book” proposals impacting the recognition and taxation of capital gains for equity investors are briefly summarized in the table below.5
Impact on Value of Loss Harvesting
The estimated impact of the proposed changes on the value of TLH will vary based on an investor’s circumstances:6
- Future disposition,
- Level of income, and
- Character of the gains offset by losses: short-term capital gains (STCGs) versus long-term capital gains (LTCGs).
Although, generally speaking, the value of tax-managed strategies tends to increase as tax rates rise, under these specific proposals, there are also scenarios where no change in value is projected as well as one situation where a decrease in value is estimated. The estimated value of TLH can still be quite advantageous even for situations where the benefit is projected to decrease.7
Estate and Gift Dispositions
At Aperio, we currently distinguish between two scenarios when presenting after-tax active return estimates: estate/donation and liquidation.10 Estate/donation reflects the assumption that the TLH portfolio will not be liable for capital gains taxes on unrealized gains at the end of the investment horizon, whereas liquidation assumes the portfolio eventually will be converted to cash, and gains and losses will be recognized. The unrealized appreciation on gifted assets is not currently eliminated or taxable at the time of the transfer, and the cost basis carries over to the donee.
Under President Biden’s tax proposals outlined on the campaign trail and in the “American Families Plan,” it is unclear whether the step-up in basis at death would simply be repealed or whether appreciated assets passing through an estate would also become a gain-recognition event.
The “Green Book” proposals clarify the Biden administration’s intent for estate (and gift) events to be treated as recognition events. Portfolios passing through an estate would be treated similarly to a liquidation event, and the value of tax-loss harvesting would likely decrease, although benefits remain. A silver lining to such treatment is that gain recognition would reset the basis of a portfolio and facilitate future TLH opportunities.
Accelerating Gains or Pausing TLH in 2021
At Aperio, we have generally cautioned against accelerating gains or pausing TLH in 2021, except in very specific circumstances. Although most of the changes proposed in the “Green Book” wouldn’t take effect until after 2021, the proposed effective date for taxing the long-term capital gains of high-income taxpayers at ordinary income tax rates is after “the date of announcement.”
Although not specified in the “Green Book,” it may be referring to dates in late April or late May, when “The American Families Plan” and the “Green Book” were released. Either date could negate the benefits of accelerating gains or pausing TLH in the future.
Midyear, retroactive tax rate increases have historically not been common; however, it’s possible that inclusion of the proposals in the “Green Book” increases the odds of this outcome.
It’s important to keep the “Green Book” proposals in perspective. Although they provide a concrete starting point for future negotiations, Congress will ultimately determine what provisions are included in future tax bills and their effective dates.
Many proposals included in prior “Green Books” have never been passed into law. For example, both the Fiscal Year 2016 and Fiscal Year 2017 “Green Books” proposed treating a gift or transfer at death as a gain realization event.11 The Biden administration is not the first to propose this change.
It’s possible that some of these capital gains proposals may need to be watered down for a bill to pass. For example, it’s feasible that Congress will pass a much more moderate long-term capital gains tax rate increase than is being proposed. It’s also conceivable that some of the more drastic proposals, such as treating a transfer of appreciated property at death as a gain-recognition event, may need to be thrown out completely for Democrats to reach a consensus or alternatively could be repealed the next time there is a shift in political power in Washington.
We understand that many clients and advisors feel anxiety about these capital gains proposals. We acknowledge that this situation is challenging. Although there is little clarity at this point on what Congress may ultimately pass, the current tax environment is dynamic and may shift quickly. We will continue to monitor changes in DC and provide further updates and analysis.
Other Tax Regime Blogs
- Repeal of Basis Step-Up: Third Time’s the Charm?
- Loss Harvesting with Inflation-Adjusted Gains
- Tax Planning Under Election Uncertainty
- Impact of Biden’s Capital Gains Proposal on the Performance of Loss-Harvesting Strategies
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