Despite the alarmist articles you might be reading in the press, most people won’t be affected very much, if at all, from the tax proposals that are percolating through Congress. If the bills pass in their current form, then individuals who make less than $400,000 a year won’t see any increase in their ordinary income or capital gains rates, and husband and wife taxpayers with less than $7 million—or maybe $10 million—in net worth still won’t have to worry about paying federal estate taxes.
But the proposals are creating some challengers for certain taxpayers, which would have to be planned for. Individuals who are earning more than $452,700 a year, and joint filers reporting more than $509,300, are looking at a top marginal tax rate of 39.6% on income above that amount—up from today’s 37%. For them, it makes sense to shift income, if they can, from 2022 into the 2021 tax year.
People who are selling a business, or selling a home or investment real estate with a lot of appreciation, could be facing an even bigger challenge. For taxpayers who report $1 million in adjusted gross income in any given year, the Biden proposal would raise the tax rate on capital gains—that is, on appreciation at sale above the purchase price—from today’s 20% to the ordinary income rate, which would be 39.6% plus a net investment income surtax of 3.8%.
Who would report $1 million in adjusted gross income? Small business owners who are planning to sell their firms might experience a one-time event where they pop up over that threshold—and find themselves paying more than double the amount they expected to Uncle Sam on the transaction. Similarly, anyone who has a highly-appreciated real estate investment might breach that threshold, and some homeowners, if they combine the sale of an expensive house with the rest of their income, could find themselves with an unpleasantly unexpected tax bill.
There are ways to plan for this. The easiest is, if the sale is imminent, to have it take place this year, under today’s 20% capital gains rates. If that isn’t feasible, the business owner or real estate investor could negotiate an installment sale, where only a part of the money is received each year, over a period of years, keeping the total income below the $1 million threshold. But these things have to be planned for now, before the new law takes place—and, of course, the complicating factor is that until the law is passed, nobody knows exactly what it will contain.
Written by Bob Veres