Markets & Research
After a turbulent and divisive election season, the U.S. political sphere has finally received some certainty, with President-elect Joe Biden set to preside over a Congress controlled by Democrats. For investors, the focus now pivots to a handful of interlocking questions: Which financial and investment policies will the incoming administration prioritize? What are the odds of those measures becoming law? And, what does it all mean for tax and wealth planning?
Biden campaigned on a sweeping agenda that included expanding the Affordable Care Act, building out green infrastructure to reach net-zero emissions by 2050 and raising taxes on people who earn more than $400,000 a year, including tax hikes on long-term capital gains and qualified dividends.
Additionally, last week Biden unveiled a $1.9 trillion COVID-19 response plan that would speed vaccine deployment, hire health care workers, fill out unemployment benefits and send a further $1,400 in direct aid to adults beyond the $600 checks already included in the federal government’s year-end stimulus package.
The coronavirus relief bill may need to be cut back to garner Republican votes, but it stands a good chance of passing with bipartisan support, says Capital Group political analyst Matt Miller.
“It’s about getting assistance out the door to communities, health care workers and families,” Miller explains. “I think Biden can attract the 10 Republicans he needs to bypass the filibuster, especially since there’s such a desire for unity right now.”
Beyond that, Miller expects Biden to pursue another large financial bill encompassing tax increases, though the timing would depend on economic conditions and the new administration’s success at curtailing the coronavirus.
Biden has proposed several substantive tax changes: lifting the top marginal income rate to 39.6% from the current 37% for taxable incomes exceeding $400,000; taxing long-term capital gains and qualified dividends at the ordinary income tax rate for income above $1 million, which could nearly double the current rate; limiting itemized deductions for wealthier households; and scaling back lifetime gift and estate tax gift exemptions to “historical norms.”
However, Biden is likely to encounter stiffer resistance to further-reaching policies, including tax increases. Though Democrats hold sway in Congress, they do so by the slimmest of margins. Democrats have only a thin majority in the House and will have to rely on Vice President Kamala Harris’s tie-breaking vote in an evenly divided Senate. Procedural rules limit the kind of legislation that can proceed without a filibuster-proof 60 votes in the upper house, so at least some bills would need Republican support. And the Democrats aren’t a monolithic bloc; the more progressive elements of Biden’s agenda could face resistance within his own party.
Passing such large-scale changes would likely require a Senate process known as reconciliation, which allows legislation to pass the chamber with a simple majority provided the measure doesn’t add to the federal deficit over a 10-year period.
“The challenge in reconciliation isn’t necessarily the Republicans — it’s moderate Democrats,” Miller says. “They don’t want to hurt employers, especially in the current situation, when we’re in need of job growth. And some of them are facing reelection in purple districts in 2022.”
There’s also been a push by some Democrats to remove the cap on federal deductions of state and local taxes, which was added as part of the Tax Cuts and Jobs Act in President Donald Trump’s first year in office. Although Biden hasn’t weighed in on removing caps on so-called SALT deductions, New York Sen. Chuck Schumer and a handful of other Democratic members of Congress have sought to remove the $10,000 limit.
Still, the momentum clearly leans toward higher taxes in the future.
“There will definitely be higher taxes on high earners and the wealthy,” Miller says. “I think Biden will have to moderate a little from his campaign promises. But taxes will almost certainly rise on high earners.”
Investors have a lot of tools with which to blunt the impact of rising taxes, says Anne Gifford Ewing, a senior trust and estates specialist at Capital Group Private Client Services.
“If there’s a transaction that will subject you to capital gains or ordinary income taxes that you’ve been putting off, it might make sense to consider doing it now,” she says. That could include diversifying a long-held concentrated stock position or selling some stock options through your employer. “And we’ve long championed that our clients who are likely to leave assets to their kids consider Roth conversions,” she adds.
Regardless of any actions by the Biden administration, the government is already set to take a bigger bite of estates in coming years. The higher limits were established in 2017’s Tax Cuts and Jobs Act, which also set them to expire in 2025.
“We already know gift and estate tax exemptions are scheduled to decrease — that’s written into the current law,” Gifford Ewing says. “The real question is, will anything happen before the exemption amounts are scheduled to sunset at the end of 2025? And if tax law changes are made in reconciliation, could those changes be made retroactive to the start of this year?”
Currently, up to $11.7 million per individual is exempt from gift or estate taxes. Changing those rules to be retroactive would be difficult and unlikely, Gifford Ewing says, so investors who expect to have taxable estates and want to make gifts should discuss options with their advisors now rather than waiting.
Furthermore, “we modeled how much more an investor could owe in taxes if they delay gifts,” Gifford Ewing adds. “There’s a price to waiting even if the tax law doesn’t change this year.”
There is a variety of estate planning vehicles that can help reduce the size of your taxable estate. Certain kinds of trusts can help you transfer wealth to your loved ones and charitable causes while potentially limiting your tax burden.
“We try to give our clients a plan that is tailored specifically to their long-term needs and goals,” Gifford Ewing says. “It’s important to do an analysis with your Private Wealth Advisor, legal counsel and tax advisors before making decisions.”
But if you’ve decided that taking one of these actions is a wise move, “consider doing it now,” she stresses. “It seems almost impossible that tax rates could go lower in the foreseeable future.”
Statements attributed to an individual represent the opinions of that individual as of the date published and do not necessarily reflect the opinions of Capital Group or its affiliates. This information is intended to highlight issues and should not be considered advice, an endorsement or a recommendation.
This material does not constitute legal or tax advice. Investors should consult with their legal or tax advisors.