Executive Summary
Although there is still a lack of clarity on what capital gains tax changes may be passed, when they will be passed, or when they will become effective, in this blog post, we provide relevant updates and share steps advisors can take now to help clients prepare for potential changes.
- The risk of retroactive changes may be decreasing
- The capital gains rate increase could be significantly lower than proposed
- Capital gains planning opportunities exist
- Don’t delay planning conversations
Risk of Retroactive Changes
Although Congress has the constitutional authority to make retroactive tax increases, they have historically been the exception rather than the rule.
In fact, of the five major tax rate increases since 1980, only one had a significant retroactive effective date. The only major capital gains rate increase since 1980 was not made retroactive.
Even if legal, retroactive tax rate increases can be politically unpopular amongst constituents and lawmakers alike, for obvious reasons. Retroactive tax rate decreases, unsurprisingly, tend to be more welcomed by the public.
In 1993, a significant number of both House and Senate Democrats voted against the retroactive tax increase that President Clinton eventually signed into law.
Assuming no Republicans vote for tax rate increases this year, Democrats have no room for dissent in the Senate and very little room in the House if they hope to pass major tax reform in 2021.
If 1993 is any indication, achieving that level of consensus on a retroactive tax rate increase may be very challenging.
Retroactivity is generally deemed more palatable for a bill passed very early in the year than it is for a bill passed late in the year, and many tax policy wonks have opined that the closer we get to the end of the year before a tax bill is signed, the less likely that any provisions will be applied retroactively.
This is important to keep in mind given that we’re in August, Congress is on a five-week break that began around August 9, and we still haven’t seen any formal legislative language.
Capital Gains Rate Increase Could Be Lower than Proposed
Presidential tax proposals are not formal legislative bills. They are more like an administration’s tax “wish list.” They serve as a starting point for future negotiations but rarely become law in their original form.
Senator Manchin of West Virginia, a moderate Democrat, has recently suggested that the capital gains rate should be increased to only 28%.4 This is significant since every Democratic senator effectively has veto power over any tax bill, and moderate Democratic senators like Senator Manchin may play an outsized role.
Some tax policy experts have similarly suggested that the capital gains rate could end up in the 25% to 30% range, rather than nearly doubling to 39.6% as proposed by President Biden.
A much smaller capital gains rate increase than originally proposed could certainly impact the economics of decisions such as whether to accelerate gains to 2021.
Additional Capital Gains Planning Opportunities
Much of the discussion around capital gains planning in 2021 has centered on whether high-income taxpayers should accelerate gains or pause loss harvesting in anticipation of a much higher long-term capital gains tax rate in the future. Aperio has already covered these decisions in great detail.5
The recent Treasury “Green Book” contains other important capital gains tax proposals that have received far less attention. Some of these proposals are highlighted below, along with relevant planning considerations if these were signed into law.
Notably, if these proposals were to pass, in the future, only transfers of cash and unappreciated assets could be made without trigging capital gains consequences.
Under current law, it is common for some taxpayers to gift high-basis assets and retain low-basis assets in order to receive a step-up in basis when the low-basis assets are passed through an estate. If the Biden capital gains proposals were to pass, in certain instances, it could become advantageous for certain taxpayers to gift low-basis assets before the changes become effective.
Don’t Delay Capital Gains Planning Conversations
Given the slim Democratic majorities in the House and Senate and the legislative hurdles that remain, we would not be surprised if major tax reform is not passed into law until much later in the year.6
Congress seems to have developed a bad habit of doing this. Some of the most significant tax legislation passed in recent years was not passed until late in the year.
Although some types of capital gains planning such as selling publicly traded securities may be accomplished with the touch of a button, other types of planning may require more time and energy:
- Business sale due diligence
- Setting up a trust
- Appraisals or valuations
If legislation is not passed until late in the year, last-minute planning may be rushed or even become impractical, depending on the client’s circumstances. Additionally, it’s common for advisors like CPAs, attorneys, and valuation professionals to be swamped at year-end and not have much additional bandwidth.
Thoughtful tax planning can take time. Although there are still many unknowns, in some cases, it may be wise to begin discussing “what-if” scenarios with clients and obtain planning buy-in today rather than waiting until a tax bill has been introduced or signed into law.
It may be possible to lay some of the planning groundwork today and increase optionality without “pulling the trigger” by taking steps such as obtaining appraisals, drafting trust agreements, or beginning due diligence. You might think of this as capital gains insurance. Clients may then be able to defer their final decisions, such as whether to sell a business and realize capital gains this year, until there is more legislative clarity.
Conclusion
Given that it’s nearly September and we still haven’t seen any formal legislative tax language, perhaps Coach Lou Holtz was referring to Congress when he said, “When all is said and done, more is said than done.”
Despite the lack of clarity at this point about what may happen this year, the legislative process is dynamic and can change quickly.
Due to upcoming showdowns between moderates and progressives, significant concerns about the debt level, and future wrangling over hot-button issues like the SALT (state and local tax) deduction cap, the magic eight ball appears optimistic that this fall could be eventful and interesting. We will continue to monitor legislative changes and provide updates and analysis.
Other Tax Regime Blogs
- Impact of Green Book Capital Gains Proposals on Loss-Harvesting Strategies
- Repeal of Basis Step-Up: Third Time’s the Charm?
Send questions or comments to blog@aperiogroup.com.
