A lot of commentary is out there following President Biden’s speech last week on spending and tax proposals. As you all probably realize, getting a tax bill through the House and Senate successfully is nearly impossible and especially now that Senate is split 50/50 with the VP there to break a tie for the Democrats. And don’t forget that the Dem’s have an historically low majority of only 3 seats in the House which makes House Majority Speaker Nancy Pelosi’s job incredibly difficult in terms of holding her members together. You will hear that mantra constantly as party efforts to craft a compromise crawl along at a snail’s pace with estimates it may not come through until September and likely later.
So with that….where are we when it comes to potential changes in tax laws?
What Biden Put on the Table
There are two spending proposals in motion. First is the American Jobs Plan and the second the American Families Plan. For the purposes of this discussion, I am going to combine the two proposals, totaling roughly $4 trillion, and take a general look at how the administration is proposing to pay for it all. This remains extremely fluid but here is the base case for tax questions that are on people’s minds.
Individual and Corporate Rates
- 39.6% from 37% on top individual rate (families with Adjusted Gross Income (AGI) above $509K & individuals above $452K) [Note: 39.6% was lowered to 37% in the 2017 Trump Tax Bill]
- 26% from 21% on corporate rates (25-28% is the range for negotiations)
- Effective Date 1/1/22
Estate Tax
- The step up in basis would still exist but only for gains less than $1 million (or $2.5 million per couple when combined with the $500,000 exemption for real estate i.e home)
- Some exemptions for charitable donations & family-owned businesses/farms
Cap Gains & Dividends
- 20% statutory rate goes to very high 20s
- 3.8% investment income surtax for those earning $1 million or more. It would not apply to AGI in excess of $1 million [Note: Roughly 0.3% of taxpayers (about 540K people) reported income greater than $1 million in 2018]
- Growing likelihood that this will not be retroactive to 1/1/21 BUT will not have an effective date of 1/1/22 either. It will depend on how the committee chairmen decide to move forward should it be in the final package. If it does, best guess would be this Fall.
State and Local Taxes (SALT)
- Some relief in the SALT cap, but not going back to pre-2017 where there was no cap
- Property tax is the most important and largest part of SALT
- Best guess would be a raise in the current $10,000 cap to $50,000 (at most)
- Return of the Pease Rule which was repealed in the Trump Tax Bill.
- In short, the rule limits the amount certain high-income taxpayers can claim in the way of Itemized Deductions.
- The rule required that you would have to subtract 3% from the affected itemized deductions (SALT, mortgage interest and certain miscellaneous deductions) you were claiming if your AGI was above $261,500 for single payers and $313,800 for married filing jointly.
- It’s not clear if those thresholds would be increased should it be part of the final package.
The Pressing Question: Does the Stock Market Care About Higher Capital Gains Taxes?
It is logical to assume that an increase in the capital gains tax rate would cause people to rush out and sell stocks that have significant gains. But If history holds, the simple answer to the question is No. Why?
A recent Wall Street Journal article explains, and I will summarize:
- Recent studies show that only 25% of U.S. corporate stocks are held in taxable accounts. That number is down from estimates of more than 80% held in taxable accounts in 1965.
- The rest appear to be held in accounts that are exempt from taxes, including retirement accounts, pension funds and, in many cases, assets owned by foreign investors.
- And as I noted above, the higher rate proposed would only apply to households earning more than $1 million a year. (i.e., 540,000 tax filers)
- For the uber rich with high value, low basis investments, there are many tax avoidance strategies whereby assets can be put into certain types of trusts that work to minimize their tax burden without selling the assets. (A boon for estate tax attorneys)
- Anecdotally, when capital gains taxes were raised in 2013 along with the addition of the 3.8% surtax, the S&P 500 rose over 30% with dividends.
- And when taxes were cut in 2018, the S&P 500 returned a negative 4.4% for the year.
Wrapping Up
I could spend a lot more time on additional proposed tweaks to parts of the tax code but I would be putting you to sleep if you aren’t already. As I started with above, proposed tax law changes are very fluid and are probably the most difficult types of legislation to find agreement on and this will be no different. Battle lines are already being drawn and news outlets across the spectrum will breathlessly bring us updates at every turn so take this as a starting point.
As Benjamin Franklin wrote in a letter back in 1789, two years after the signing of the US Constitution, “In this world nothing can be said to be certain, except death and taxes.”
Reminder:
Mountain Capital Investment Advisors is celebrating our 10th anniversary on May 15th, 2021 at our brand-new office! We would love for you all to come celebrate this milestone with us, as we would not be here without every one of you.
