There are only two certainties in life: Death and taxes. And where the latter are concerned, a global pandemic, economic disruption and a "blue" shift in US politics mean that taxes are likely to rise, such as on HNW individuals. We recently spoke to the US wealth management firm about what it thinks is on the cards.

Now that the administration of Joe Biden is settling in – and with a Democrat-controlled Congress – wealth advisors are thinking about tax. Given the horrendous economic and financial costs of lockdowns associated with COVID-19, and concerns that the crisis has widened wealth inequality, it is highly possible that tax hikes are coming, particularly on the supposed “rich”. 

So what to expect?

A strong possibility is that capital gains tax will go up from its current rate of 20 per cent to the upper twenties, if not higher, Joan Crain, senior director and global wealth strategist at BNY Mellon Wealth Management, told Family Wealth Report recently. 

The Biden campaign last year included a proposal to almost double the current rate of CGT by putting it in line with an individual’s ordinary income tax rate. Biden proposes to accelerate restoring the top income tax rate to the pre-2017 rate of just under 40 per cent. If these increases were to become policy, they would be some of the largest since 1968.

Such a tax would apply to any long-term capital gain incurred by a taxpayer in the highest income tax bracket, she said.

“Although a 40 per cent rate is generally considered unlikely,  it is very possible that the top rate will be increased to somewhere between the current 20 per cent and the campaign proposal, such as to 26 or 28 per cent, where it has been in the past,” she said. 

“We need to plan for this although people shouldn’t panic and make hasty decisions which later prove unwise,” Crain said. 

Although considered unlikely, any tax hike could be imposed retroactively – this has happened with taxes before, as in the early 1990s when the Omnibus Reconciliation Act was signed into law in August 1993, applicable to transactions on or after January 1, 1993. Further, the US Supreme Court unanimously upheld the retroactive repeal of a tax deduction in US v. Carlton, 512 U.S. 26 (1994), stating: “Tax legislation is not a promise, and a taxpayer has no vested right in the Internal Revenue Code.”

What happens if people decide to cash in on their investments now to avoid any new, higher CGT rates? Crain argues that might not work out. 

“Another problem with investors saying `I need to get rid of this gain before rates go up’ is that you don’t want to let the proverbial tax tail wag the investment dog,” she said.

One important and positive step investors can take is to diversify if their assets are currently highly concentrated, as can often happen, especially during a strong stock market. “In such cases, we encourage clients that this is an ideal time to take the important step of rebalancing their portfolios to get more diversified,” she said. 

Another approach for wealthy individuals who want to mitigate the potential tax on large, embedded gains is to gift assets to family members in lower tax brackets. The cost basis is carried over to the recipient, so that when those family members sell the asset, they pay at their lower capital gain tax rate. One point to note is that gifting an asset to mitigate CGT will use up some of the donor’s existing gift tax exemption.  Further, to protect large gifts to younger family members, many gifts are made into trusts.

In addition, although not usually a good idea from an investment perspective, older taxpayers may choose to hold on to highly appreciated assets until they pass away, at which point the assets will flow to their heirs with a cost basis stepped up to the market value on the parent’s date of death. However, another proposal floated during President Biden’s campaign was to do away with the “step up” in cost basis at death, adding uncertainty to this strategy, Crain said. 

“Some people will not sell [an asset] and wait for a new administration to come in and lower the rates down again. So, if capital gains go up a lot, people may simply not sell. There have been studies that show the government will often get less tax under higher capital gains tax rates than when rates are low and taxpayers are more willing to sell,” she said.

The atmosphere around tax is unsettled, she said. 

“We are getting a lot of enquiries and the mood out there is nervous - `what can we do?’” We are getting calls from people even thinking of leaving the US, although they don’t realize that they don’t avoid any of these taxes because the US taxes citizens on a worldwide basis,” she continued. 

COVID-19 makes some advisor-client conversations and interactions more difficult, although within BNY Mellon WM, work has continued smoothly, Crain said.

“Some [clients] have said they will wait until they can meet in person….although over time that has eroded a little bit. However, there are still a lot of people who want to sit down with someone with whom they feel comfortable before making important investment or wealth planning decisions,” she said.

BNY Mellon WM gives this summary of potential changes:

-- Individual tax rate: Restore top tax rate to 39.6 per cent;
-- Long-term capital gains and qualified dividends: No preferential rate for taxpayers with income over $1 million; 3.8 per cent surtax on net investment income;
-- Carried interest: Tax at ordinary income levels instead of capital gains; 
-- Itemized deductions: Cap deductions at a 28 per cent rate; repeal the $10,000 state and local tax limitation; 
-- Social Security Payroll Tax: Tax of 12.4 per cent applied to income over $400,000; 
-- Estate and gift tax: Reducing estate/GST exemption to $3.5 million and gift tax exemption to $1.0 million; potential for higher estate/giftGST tax rate (currently at 40 per cent); 
-- “Step-up" in Basis at Death: Repeal step-up in basis at death; capital gains subject to tax at death; 
-- Corporate tax rates: Raise to 28 per cent.