Householders making more than $400,000 are going to see higher taxes, putting a premium on smart financial and estate planning. Wealth managers discuss what approaches to take and what sort of conversations are taking place.

If there is one single point of agreement about the US fiscal policy situation it is that high net worth individuals are in the firing line. 

With the Joe Biden administration aiming to spend a combined total of $6 trillion in infrastructure and other programs, it has identified HNW individuals as a source for footing the enormous cost (although skeptics may note that the broad middle class usually gets hit in the end). Ever since the Georgia senatorial runoff races in January that put the Senate into Democrat hands, the tax hit has been a matter not of if but when. 

The next few months promise no let-up in work for the financial planning industry.

“Whether it’s increasing the top income tax rate to 39.6 per cent, raising the top long-term capital gains rate to match it, eliminating the step up in basis at death for gains in excess of $1 million, or phasing out the qualified business income deduction…the message is clear: if the Biden administration is successful in seeing its tax legislative priorities through, households making more than $400,000 annually will likely see their taxes go up,” Jack Nuckolls, national technical leader of BDO’s private client services practice, and Todd Simmens, BDO’s national managing partner of tax risk management, said. 

“Planning amidst such uncertainty is a daunting task, but an essential one if high net worth individuals want to quickly adapt when changes do come to pass. It’s important to note that the legislative process can be a lengthy and arduous one, which can provide individuals with some time to plan ahead. 

“We recommend that folk connect with trusted advisors who can help them model the potential impact of these changes (and the myriad variants still on the table), to assess how they each could affect their overall tax liability, and work with them to develop potential plans of action that can be executed when there is more clarity," Nuckolls and Simmens told this news service in a note. 

“These plans may include strategies such as increasing tax-deductible charitable contributions, re-evaluating wealth transfer structures already in place, or using available deductions in the short-term. They can also explore accelerating capital gains when appropriate, entering into installment sales, or donating to a charitable remainder trust as ways to reduce the impact of future tax changes. This type of scenario planning is crucial to crafting thoughtful tax strategy during times of disruption,” they wrote.

In a separate call, another BDO senior figure, Jeff Kane, noted recent talk of some HNW Americans thinking of leaving the country. A number of countries have rolled out programs to attract HNW individuals, such as Spain, Portugal, Italy and Malta. At the same time, options for people to put resources outside the reaches of the State have been squeezed.

There has been a general assault on financial privacy, Kane said, noting developments such as the demise of Swiss bank secrecy, the various leaks of data in Panama, the Bahamas and other international financial centers.

“People are willing to be transparent, but the push for transparency can go too far and start to infringe on privacy. Clients want to pay their tax liability….but the issue is their privacy, their reputation and their safety [such] as when information goes public,” he said. 

This news service asked him about calls in some nations, including in the US (in the case of Senator Elizabeth Warren) for wealth taxes. Kane is largely unimpressed by them: “There used to be a lot of countries with wealth tax….they were incredibly hard to administer and they were self-defeating.”

Taxes may be inevitable but their rates aren't
Dave Donabedian, CFA, at CIBC Private Wealth Management, notes that with certain taxes, investors must remember that no tax changes are set in stone. 

"Given some of the early feedback from members of Congress (including in the president’s own party), the 43.4 per cent may not be viable, and a lower rate could eventually be settled on. Importantly, prioritizing taxes as the primary catalyst for investment decisions has a high probability of backfiring. In the case of a stock, the quality and growth potential of the company are likely to be bigger determinants of the after-tax investment return than the capital gains rate in effect at the time," he said. 

"The other thing to remember is that there is no such thing as a permanent change to the capital gains tax. Any modification enacted in the months ahead would be the third in less than twenty years. In the decade ending 1986, the capital gains tax rate was changed four times. Wherever it is headed in the immediate future, can anybody have confidence in what the rate will be five years down the road?" Donabedian continued.

He also argued that high CGT rates tend to be self-defeating in terms of raising revenues, because investors adjust behavior.

"All else being equal, an investor subject to the new higher rate would have a lower after-tax return on profitable investments that are sold. However, that static mathematical approach misses an important variable: dynamic investor behavior. Investors build tax changes into their decision-making, impacting when and how they realize investment profits. The best evidence of this is that increases in the capital gain tax rate have not been associated with more revenues for the government. In fact, one of the reasons the near-50 per cent tax rate in the mid-1970s was scrapped was that it produced lower federal revenues. Government legislates, investors adapt," Donabedian added. 

For more commentary on the Biden tax plans see here, and see here.