Preparing for Tax Hikes: Plan But Don’t Panic

As the administration looks to fund new multitrillion-dollar economic packages, there is a strong probability of at least some tax hikes ahead. Here’s a look at what could happen and how to mitigate potential increases.

Following the passage of the $1.9 trillion American Rescue Plan Act and the announcement of the $2 trillion infrastructure-focused American Jobs Plan, President Biden has announced the $1.8 trillion American Families Plan, which would make expanded child tax credits permanent, implement federally-mandated family leave and expand access to education and child care.

To fund the American Jobs Plan, President Biden has proposed an increase in the corporate tax rate to 28% from 21%, a move he discussed throughout his election campaign. He has also proposed raising taxes on multinational corporations and implementing measures to stop the offshoring of profits.

The American Families Plan proposes funding the social causes by increasing income taxes for taxpayers earning more than $400,000 and increasing capital gain taxes for taxpayers with income over $1 million. 

With a projected 2021 budget deficit estimated at $2.3 trillion,there is a strong probability of at least some tax increases ahead, particularly for upper income taxpayers. In addition to possible increases in the individual tax rate, a group of influential lawmakers introduced the Ultra-Millionaire Tax Act in early March. This plan would impose an annual wealth tax on households and trusts that have a net worth in excess of $50 million and is designed to reduce income inequality.

The following chart outlines key tax increases as proposed by President Biden in his tax plans and during his election campaign. While it is doubtful that all of these will be enacted immediately, or even at all, there seems to be some agreement as to which are the most likely to be the initial targets. Exhibit 1 summarizes current thoughts as to the likelihood and extent of each item.

Exhibit 1: Potential Tax Changes

Here's a look at some of the key tax areas where significant increases would affect individual taxpayers, how and when these increases may become effective, and an overview of various strategies available to mitigate potentially higher taxes.

The Path of Least Resistance

Reversing selected provisions of the 2017 Tax Cuts and Jobs Act (TCJA) appears to offer one of the easiest places to start. Raising the 21% corporate income tax rate does not seem a radical move. Taking it up to the proposed 28% is attractive, as estimates indicate this would raise an additional $1 trillion in revenue over the next 10 years.2 However, this large an increase may be a nonstarter in Congress. A possible first step could be an increase to 25%. In addition, a substantial increase in the Global Intangible Low-Tax Income (GILTI) and the elimination of the Foreign Derived Intangible Income tax deduction would further hurt companies with foreign affiliates and foreign profits.3

Similarly, bringing the highest marginal income tax rate for individuals with taxable incomes greater than $400,000 back up to 39.6% from the current 37% is a less drastic move than many of the other changes Biden proposed during his election campaign and in the American Families Plan. The 3.8% Medicare surtax on investment income would remain. Reverting to a top total tax rate of 43.4% would affect the more affluent taxpayers and arguably just return rates to the prior status quo.

The TCJA also introduced a restriction on the maximum deduction for state and local taxes of individual taxpayers to $10,000. This highly controversial item, known as SALT, could be a popular target for reversal, particularly among Democratic legislators from high-tax states that are facing waves of out-migration, although it was not included in the American Families Plan. Given that this would benefit upper-income taxpayers most, the deduction, if reinstated, may be capped at a lesser rate than the maximum tax bracket.4

Further proposed restrictions on itemized deductions include a 28% cap (probably with an exception for charitable gifts and mortgage interest), and restoring the Pease limitation for taxable incomes greater than $400,000.5 While these have received less media attention and are not included in the American Families Plan, they could be attractive moves given the fact they affect primarily higher income taxpayers.

Under the proposed Ultra-Millionaire Tax Act, issued by Sen. Elizabeth Warren (D-MA) and several other lawmakers, households and trusts that have a net worth in excess of $50 million would pay a 2% annual tax, while those in excess of $1 billion would pay an additional 1% surtax (3% tax overall) on their net worth. While this proposal caused a stir among advisors and wealthy clients when announced, the likelihood of it being passed in the foreseeable future appears slim.

Capital Gains in the Crosshairs

There has been considerable discussion over ways to capture more tax revenue from capital gains. The American Families Plan  advocates increasing the tax rate on both capital gains and qualified dividends from the current 20% (or 23.8% including the Medicare surtax) to a rate equal to that for ordinary income. Such a monumental jump seems unlikely, and in fact could be counterproductive. Studies show that higher capital gains tax rates do not lead to a significant change in economic growth; in fact, higher capital gains tax rates are a disincentive for investors to realize capital gains, resulting in less tax actually collected.6 This fact notwithstanding, given the focus on income inequality, bumping the rate up to the 25-28% range would appear likely, possibly only for those in top tax brackets or those earning over $1 million annually.

Further attacks on capital gains include taxing unrealized capital gains under an annual “mark-to-market” plan favored by Senate Finance Chair Ron Wyden. This is a major change and is not likely to become law in the immediate future. Another proposal in the American Families Plan  is the elimination of the step-up in the cost basis of appreciated assets at death. The plan takes the form of a “deemed disposition” tax imposed immediately at death as is done in Canada.7 This, as with Senator Wyden’s proposed tax on unrealized capital gains, poses administrative challenges and is likely to face stiff opposition.

Related to the elimination of the step-up in cost basis at death are increases in estate and gift taxes. President Biden’s pre-election proposal called for a reduction of the current $11.7 million per person estate and gift tax exemption to the pre-TCJA level of $3.5 million for estates and $1 million for gifts. These changes are not included in the American Families Plan, but they are on the radar of several influential Democrats. Uncoupling the gift tax exemption from the estate tax exemption has not been popular and appears unlikely. However, a reduction in the exemption, possibly to something between the current $11.7 million and the proposed $3.5 million, may be more palatable. Similarly, raising the rate on assets above the exemption (currently 40%) appears less controversial. Also related to increased transfer taxes are restrictions on the valuation discounts available for gifts and inheritances of partial interests and illiquid assets. These have been a target of past administrations, which, although struck down by President Trump’s executive order, remain a priority item.

The attacks on the preferential rate for “carried interest”8 have had bipartisan support. Taxing this as ordinary income rather than long-term capital gains would apply to those earning more than $1 million annually, which appeals to progressives seeking ways to reduce income inequality. This seems a likely near-term item, as it is included in the American Families Plan.

Retroactivity: The Elephant in the Room

Equally concerning to more affluent taxpayers is the possibility that tax increases will be retroactive to the beginning of 2021. This would mean actions taken now, which under the current tax regime would generate a certain level of tax or possibly no tax, may end up being taxed more heavily by the time 2021 tax returns are due.

While at first blush this appears sneaky and possibly illegal, retroactive tax changes can be done for a “legitimate purpose,” which includes changes in income taxes. In fact, the August 1993 Omnibus Reconciliation Act changed taxes retroactively to January 1993.

However, retroactive increases are highly unpopular and so quite rare. More often, tax increases become effective at a future date. For example, the 3.8% Medicare surtax enacted in 2012 became effective January 1, 2013. So although theoretically possible given the composition of the Senate, changes enacted in 2021 are more likely to be effective in 2022.

Possible Strategies to Mitigate Tax Increases

So what are taxpayers to do? Now is the time to plan, but not panic. Remember the old but relevant advice not to let the proverbial “tax tail” wag the dog. History is littered with examples of hastily crafted documents and asset transfers done in front of rumored tax changes and later regretted.9

To guard against the possibility of retroactive changes, some advisors and taxpayers have felt it could be prudent to wait until later in the year to complete a transfer. However, with a good part of the year already behind them and the growing likelihood of tax increases, those with large taxable estates who intend to leave significant amounts to their heirs may want to start planning now regarding how and when to do so up to their remaining exemption amounts. Although a retroactive effective date is unlikely, there is a stronger possibility that tax increases may be effective as of the date a bill is introduced in Congress. This has been done with prior increase, in order to prevent taxpayers from gaming the system.10

The plethora of alternatives can be overwhelming. Experienced counsel is critical for taxpayers in order to select and execute appropriate structures that are effective for tax savings while also working out well for their families. Below is a partial list of some of the planning strategies that may be useful in today’s environment:

1. Utilize remaining gift and estate tax exemption of $11.7 million per person, or $23.4 million per couple, by making gifts outright or in trust to your heirs.

  • This is a “use it or lose it” situation which is particularly important given the focus of the current administration on lowering the exemption.
  • Note that the IRS confirmed that there is no clawback of any previously used exemption if the exemption is later reduced before you pass away.
  • These gifts can have the additional benefit of shifting embedded capital gains to taxpayers who are tax-exempt or in lower tax brackets (e.g., charitable gifting of an appreciated asset, substitution of assets in an entity, or gifting to family members or descendants in lower tax brackets),
  • Careful consideration has to be afforded to whether to gift assets outright or to trusts, as trusts provide greater protection from creditors and tend to preserve wealth within the family.

2. Consider funding various trusts such as SLATs, GRATs, IDGTs, CLTs and other structures that benefit from low interest rates and the current historically high gift and estate tax exemption.

  • Examples of such trusts include Spousal Lifetime Access Trusts (SLATs), Grantor Retained Annuity Trusts (GRATs), Intentionally Defective Grantor Trusts (IDGTs) and Charitable Lead Trusts (CLTs).
  • These trusts are often set up as “grantor trusts” so that the grantor pays the income taxes on the trusts, allowing the trust assets to grow without the burden of federal or state income taxes.
  • The “grantor trust” status also allows the grantor to swap appreciated assets out of the trust in exchange for personally owned high basis assets, thus providing for a step-up in basis on the assets with embedded gains, which will be in the grantor’s gross estate and thus will benefit from a step-up in basis at death.11

3. The current low interest rates offer a number of planning options involving the use of credit.

  • Intrafamily loans can shift future growth to family members in lower tax brackets. Low-interest loans can allow for the transfer wealth to the borrower without using the lending family member’s gift and estate tax exemption.
  • Borrowing against an investment portfolio can avoid the realization of capital gains while rates are high. This can be used for current cash needs or to make the aforementioned intrafamily loans.
  • Similarly, families that have outstanding promissory notes (whether standalone or as a part of sale transaction) should consider refinancing those to take advantage of the lower rates without gift tax implications.

4. From an investment perspective, there are a number of strategies to consider before and after an increase in capital gains tax rates:

  • Accelerate realized gains before tax changes become law (attractive for holders of low basis assets considering current effective capital gains rates are still relatively low compared to other sources of capital income, such as nonqualified dividends and interest income).
  • Employ tax-managed strategies in an effort to manage realized gains and losses in an efficient manner.
  • Diversify concentrated positions in low basis stock by selling before year end, to lock in current capital gains tax rates.

5. If planning to sell your business, this may be the year to do so, before increased capital gains taxes and curtailed planning options such as possible valuation discounts.

6. Take advantage of valuation discounts when gifting minority interests and illiquid assets before these may be reduced or even eliminated.

7. Convert a traditional IRA to a Roth IRA to provide for tax free growth and distributions to you and your heirs in the future. Converting a traditional IRA to a Roth IRA is a taxable event that generates ordinary income for the owner. Offset the large income spike with a charitable deduction for a gift to an operating non-profit, Donor Advised Fund or private foundation.

8. Fund charitable gifts with low basis stock to benefit from an immediate income tax deduction and avoid future tax on capital gains.

Investment Considerations

In terms of investment portfolios, it is important for clients not to make any changes to their long-term investment strategy as a result of proposed tax policy changes because what ultimately gets passed can look very different. While we monitor any forthcoming tax policy changes, we continue to position investment portfolios for a cyclical global reopening. We have seen expectations for stronger growth reflected in higher yields, a rebound in earnings, a modest increase in inflation and a weaker dollar. We have been taking advantage of these trends since last summer by favoring equities over bonds and shifting from growth stocks to those asset classes which can benefit more from the cyclical global recovery, such as small-cap stocks and emerging market equity.

Equity markets are waiting and watching what is happening on the policy front and have likely already priced in some probability of higher taxes down the road. We remind clients that equity markets can do quite well under slightly higher tax rates, as seen under the Obama administration. Thus, we’d recommend not making any rash allocation changes in reaction to any proposed tax changes. Instead, tax-sensitive investors should take advantage of tax-managed equity strategies, which work to both minimize net gains and actively harvest losses to help maximize after-tax returns, and municipal bonds, which should provide attractive yields in a higher tax environment. The combination of staying aligned with investment plans and incorporating tax-efficient strategies should help to navigate client portfolios in an environment poised for potential tax changes.


The proposed changes to many areas in the U.S. tax regime are far-reaching and may significantly affect the wallets of upper income taxpayers. The question of if and when they may be enacted and become effective adds a further dimension to investing and planning around them. Investment decisions based solely on proposed policy changes can prove costly, so it is best to adhere to long-term investment strategies aligned to one's goals. Clients who are interested in pursuing planning strategies are encouraged to seek advice from their wealth managers and tax professionals to assure their choices are consistent with their goals and family situations.

  • 1. Congressional Budget Deficit, “The Budget and Economic Outlook: 2021 to 2023”, February 11, 2021

    2. Daniel L. Mellor, JD, LLM, “President-Elect Joe Biden’s Tax Reform Proposals,” Kulzer & DiPadova, P.A., January 2021.

    3.  The proposal would increase the GILTI tax from 10.5% to 21% and change the calculation to a country-by-country minimum tax rather than the current approach, which allows businesses to blend foreign income that is taxed at a high rate with income that may be taxed at lower rates. The FDII provides corporations with a significantly lower effective tax rate on income derived from products and services in foreign markets

    4. For instance, the maximum deduction could be 28% of taxpayers’ income regardless of their marginal bracket.

    5. The Pease limitation imposes a 3% reduction in itemized deductions for every dollar of income over $400,000.

    6. Herzig, Belinda; Nelson, Richard; Crain, Joan, “Tax Increases; Implications on Capital Formation and Growth,” BNY Mellon Wealth Management, January 2021.

    7. See Crain, Joan and Miller, Justin T., “Stepping Away from the StepUp in Basis at Death: A Global Perspective,” Leimberg Information Services, Inc., Email Newsletter Archive Message, September 17, 2020.
    8. Carried interest is a share of any profits that the general partners receive as compensation regardless of whether they contribute any initial funds. Although clearly compensation, it is currently taxed as long-term capital gains.

    9. Tax and legal professionals continue to deal with the aftermath of the December 2012 rush to fund trusts before an anticipated but unrealized reduction in the transfer tax exemption. Grantors and beneficiaries of these irrevocable trusts are now struggling to find ways to amend and unwind trust provisions that are ill suited to their family situations.

    10. For instance, selling appreciated assets before the known effective date of a higher capital gains tax.

    11. Basis step-up is under attack by some progressive legislators. While not considered one of the most likely tax changes, it is possible it may be reduced or eliminated in the future.

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