Should I sell stocks/bonds now or wait for the new year? The capital gain rates are always top of mind for clients, especially for those with substantial unrealized gains or business owners looking to sell their business. An increase in capital gain rates, even by a few percentage points, could make the difference between selling now or later.
Biden’s tax proposal calls for raising capital gain and qualified dividend income tax rates to a top rate of 39.6% for taxpayers with over $1 million in income. Currently, the top rate is 20% with an added net investment income tax rate of 3.8%. If this proposal becomes law then an individual with income over $1 million would pay an extra $196,000 in tax per million of capital gain over the base case. However, even if Biden wins the election and Democrats take the Senate, there will be a lag between the election and the passage of tax legislation. And plans can change.
Trump’s tax proposal calls for lowering the capital gain tax rate to 15%. Additionally, Trump has floated the idea of indexing capital gains to inflation which would exclude 2%-3% in annual appreciation from taxation. If this proposal becomes law then the same individual earning $1 million or more would save $50,000 in tax per million of capital gain over the base case.
If you expect capital gain rates to rise, you could sell stock now and reestablish the position immediately after the sale. With publicly-traded stock, recognizing the gain can be done with an actual sale, or with a constructive sale, such as a short sale against the box. Also, the wash sale rules do not apply to recognized gain, so there is no risk of having the gain deferred as there would be with selling stock at a loss and then buying it back.
If you expect capital gain rates to fall, holding appreciated stock may make sense, though this exposes you to downside risk. If you execute a hedging strategy to mitigate the economic risk, then consider the effect of the straddle rules and the constructive sale rules to avoid any unintended consequences.
To give or not to give? The estate tax is once again becoming a hot button issue even with the lifetime exemption currently set at more than $11.5 million per person. The question is whether any gift given now that uses up the exemption will be grandfathered if there is a future change to the exemption amount. The IRS has issued favorable proposed regulations so no claw-back is expected.
The worst case scenario is that you do not take advantage of the current lifetime exemption amount and then it is reduced in 2021 to $5 million or to $3.5 million. In that case, you will have forfeited the ability to give away the difference between the current amount and the future amount, which can be more than $6 million or $8 million, depending on the future exemption amount.
The best case scenario is that the current exemption amount is not reduced and you have the ability to use it in future years.
If you have not done so already, and are comfortable surrendering control of assets to the next generation, it might be a good idea to take advantage of the $11.58 million per individual lifetime exemption in 2020, or $23.16 million for a married couple. The prevailing view is that the current lifetime exemption amount is as good as it gets and using it up before it’s gone might be your best bet regardless who wins in November.
There is an old tax saying that says “may your gains be capital and your losses ordinary.” It goes without saying that being taxed at the top ordinary income rate is the worst case scenario for any taxpayer. From W-2 employees to active business owners, escaping the clutches of payroll taxes and ordinary rates is all but impossible.
The cap on the state and local tax deduction and the elimination of the 2% miscellaneous itemized deduction has hit taxpayers hard. Essentially, an increase in the top tax rate back to 39.6% without also reversing these limitations would result in a significant tax increase. Under a Biden administration, the top rate for individuals would increase from 37% to 39.6%.
The best case scenario is for tax rates to remain flat, or even come down slightly, and for there to be an elimination of the cap on state and local tax deductions. However, this is not likely to occur especially with the growing national debt. Also, keep in mind that individual income and payroll taxes represent about 85% of total tax revenue, whereas the corporate income tax represents only about 7%.
Eliminating or deferring tax on ordinary income usually makes the most sense, unless you expect rate increases and the value of such increases is expected to outpace the benefit of deferral. Thus, deferring income through retirement contributions and planning makes sense, as does making use of bonuses or accelerated depreciation, among other things.
Should you act now or wait until after the election? We recommend you start planning now and definitely wait until after the election to take action, if at all. Remember, major business decisions should be driven by the exigencies of business, not tax considerations. Think about long-term objectives. A favorite expression is that you shouldn’t let the tax tail wag the planning dog. This makes sense here too because there are lots of variables to consider and predictions, while helpful to planning, are only forecasts about what might be expected to happen in the future.
Election year tax planning should be about speeding up or slowing down something you were already thinking about doing anyway. Don’t allow fear to cause you to take actions you would not have considered otherwise because even if your political calculations prove correct, that does not mean the expected tax policy will automatically follow. Anything can happen in politics. Our best advice is to start planning now, but stay resilient and incorporate flexibility into your plans so they can accommodate different outcomes.