Billionaire's Tax

In his federal budget for fiscal year 2023 that he unveiled earlier this month, President Biden proposed a huge new tax increase on America’s wealthiest citizens. The administration labeled it the “billionaires’ tax” and promised it would finally bring fairness to our tax code by making the richest Americans pay at least 20% of their wealth gains annually to Uncle Sam.

Historically, the U.S. tax system mandates that citizens pay tax on their income, not their wealth. But Biden and his liberal cronies want to change that and add a 20% tax on your wealth gains. So, if your net worth went up by $100,000 in a given year, you would owe $20,000 on that gain – in addition to the income taxes you paid.

The good news is the latest Biden proposal to tax wealth in addition to income is not likely to become law as is, especially if the Democrats lose majority control of Congress in the November elections, as the polls widely suggest. So, they’ll try their hardest to pass something between now and Election Day. I don’t believe they can pass Biden’s massive tax increase, but we’ll have to wait and see.

Understanding President Biden’s So-Called “Billionaires’ Tax”

Billionaires are just the first targets of President Biden’s proposed tax hikes. The law is designed to affect all wealthy Americans over time, including even some in the Middle Class, although they don’t tell you that.

As noted above, Mr. Biden’s latest tax plan probably won’t be enacted, at least not in its present form. But it is a window into the wish list of liberal tax reformers. They aim to kill off a long list of tax avoidance strategies as soon as they get the votes, and they desperately need to do it this year before they lose control of Congress.

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The so-called  billionaires’ tax, which would levy a 20% tax rate on the wealth gains of successful people, is the most visible part of President Biden’s plan. It turns out this would apply not just to billionaires but to anyone worth more than $100 million.

Yet it is a threat, moreover, to people with much less money. Why? Because it’s an opening wedge. It introduces the notion of taxing paper gains—wealth increments, that is, that are unrealized income. Once this becomes a way of taxing people, some future Congress, hungry for federal revenue, could easily lower the starting point from $100 million to $10 million or even $1 million.

Besides the “billionaire” wealth tax, the Biden budget asks for a boost in the top tax rate from 37% to 39.6% for taxable incomes above $450,000 on a joint return. It includes a crackdown, applicable at all income  levels, on estate-planning strategies involving “grantor trusts.” It nibbles away at donor-advised funds, charitable vehicles used by prosperous taxpayers. It also limits the value of depreciation deductions taken by real estate investors and others.

Whether Biden can get any of this through a closely divided Senate is an open question. It likely hangs on the votes of two on-the-fence Democrats, Joe Manchin of West Virginia and Kyrsten Sinema of Arizona. Manchin appears willing to sign off on some tax hikes but not the taxation of paper gains. Sinema is hostile to tax increases except at the upper reaches of the income spectrum ($10 million and up).

Democrats Favor Elimination Loopholes in the Tax Code

Yet there’s a lot of Democratic support for a broad-spectrum attack on “loopholes,” which can perhaps be defined as anything that helps taxpayers hang onto money they have earned.

One such hole in the tax code is the “step-up,” exempting from income tax (but not estate tax) the appreciation in assets held at death. An early version of last fall’s failed Build Back Better bill would have drastically limited step-up at death. The version which finally passed in the House, but not the Senate, omitted this law change but did a lot of other damage. It attacked large IRA balances, expanded the coverage of the 3.8% investment income tax and added new tax brackets for very high incomes.

Some conservative tax experts in Washington have already spoken out in opposition to the step-up provisions in Biden’s latest tax plan, including Bill Smith of CBIZ, a national accounting and financial advisory firm, and Timothy Laffey of Rockefeller Capital Management, which provides investment advice to wealthy families.

Neither is an alarmist. They put fairly low odds on enactment this year of most loophole closers. But they agree there is growing support eliminating tax maneuvers used by the well-off to reduce the taxes they owe.

If there’s any tax bill enacted this year, Laffey says, there’s a good chance it will include: an increase in the 21% corporate tax rate; an increase in individual income-tax rates but only for high incomes; and a rule treating financiers’ carried-interest fees as ordinary income.

What Income Tax Strategies Are Safe Versus Those At Risk

What about the long term? Below is a discussion of some popular tax strategies used by people who accumulate capital. Some strategies are safe despite Biden’s efforts to increase taxes, but some are at risk. You should factor the odds of a law change into your planning.

If you do that, you might revise an estate plan that hinges on the so-called step-up. You might scale back whatever arithmetic now dictates maximizing tax-deferred retirement saving. You definitely should revisit any presumption that your tax bracket will go down in retirement.

Space doesn’t allow me to discuss all of the tax strategies which are at risk in the Biden plan, but I’ll touch on the most popular ones below, and then include the others in a link in Special Articles at the end of today’s letter. Let’s get started.

Step-Up Basis: What happens when the price of an inherited asset on the date of the decedent’s death is above its original purchase price? The tax code allows for the raising of the cost basis to the higher price, minimizing the capital gains taxes owed by the inheritor if the asset is sold later.

The reformers are right that the step-up is a loophole which favors high income Americans. It can be argued that there’s no economic reason for exempting appreciation from income tax just because the owner of an asset died while holding it.

An early version of the Biden’s Build Back Better plan would have limited the step-up to $1 million. That ceiling may be too low to get through Congress, says Rockefeller Capital’s Tim Laffey. It would mean that heirs to a modest IRA and a suburban home could get a surprise income-tax bill.

Laffey predicts that if and when Congress lowers the boom on unrealized gains it will grant a $5 million exemption that is portable, meaning a married couple could pass on $10 million of appreciated property to their kids. This remains to be seen, of course.

Any curbing of the step-up would likely apply, again with a generous exemption, to gifts as well as bequests. It’s a toss-up whether a tax reform will treat a transfer as a sale or, instead, merely require the recipient to take on the historical cost basis.

What you should do about this: Hang on to highly appreciated property and keep your fingers crossed.

Depreciation: Let’s say you buy a $1 million apartment building and claim $36,000 a year in depreciation against it, lowering your ordinary income from rent by that amount. After 10 years you sell the building for $1.8 million. Under present law you’d declare $800,000 of long-term capital gain taxed at a favorable rate (up to 23.8% federally) and another $360,000 of Section 1250 depreciation recapture taxed at a somewhat favorable rate (28.8%).

The Biden budget wants the recapture taxed as ordinary income (up to 37% now, or 39.6% when the Trump tax cuts expire). This kind of reform could definitely happen, either now or down the road. CBIZ’s Bill Smith calls this a “medium” risk.

What to do: Be less enthusiastic about syndicated real estate deals.

GRATS: Grantor Retained Annuity Trusts keep many a lawyer busy. You deposit into the trust an asset with appreciation potential, then take back an annuity of a certain dollar amount. When the annuity is over with, the asset goes to your descendants. If the annuity is large, the remainder interest has a tiny present value, so you don’t owe much gift tax.

If the asset performs, you potentially pass along millions of dollars without an inheritance tax. It appears that Mark Zuckerberg stuffed some cheap founder shares in Facebook into one of these things.

The Biden budget wouldn’t entirely outlaw GRATS. But it would impose enough limitations, says Laffey, to make them pointless for most taxpayers. Since tax reformers agree that GRATS are an unadulterated tax dodge, they are at risk in any reform plan.

What to do: Get your trust paperwork ready now. Hope that new rules become effective only after a reform bill is signed into law. If and when such a bill heads to the president’s desk, pull the trigger.

Roth Conversions

With a Roth conversion, you prepay tax on IRA money, making the account totally tax-free and so long as you are alive or your spouse is, free of minimum distributions. Assuming you pay the income tax from money outside the tax-deferred account, the conversion is a modest winner if your tax bracket is destined to stay the same.

It’s a big winner if your tax bracket is destined to go up, which will be the case for many people when the 2017 tax cuts expire at the start of 2026.

Is a Roth conversion a tax loophole? Yes and no. The House bill called for denying Roth conversions to taxpayers with more than $450,000 of taxable income on a joint return. But the effective date was going to be in 2031, which would have given people time to do conversions in the meantime, showering the IRS with tax payments.

Evidently, the legislators were inspired not so much by social justice as by their hunger for accelerated tax payments. So, it seems reasonable to conclude that your right to convert is pretty safe.

What to do: Have in place a conversion game plan for the next four years. After that you should be able to keep doing conversions, but they will probably be somewhat less valuable.

Gary D. Halbert is the president and chairman of Halbert Wealth Management, Inc. His Forecasts & Trends Weekly E-Letter may be obtained free of charge by subscribing at www.halbertwealth.com.