By Joseph Goldy, AAMS®
The recent release of the American Families Plan marks the third part of President Biden's Build Back Better Initiative. Several proposals make up this plan, but it is important to note that they are just proposals at this point and will have to make their way through Congress, where legislators will undoubtedly modify many of the provisions.
Highland has been following the President's proposed legislation carefully, along with its potential impact on planning opportunities for clients. As the year progresses and these ideas go through the legislative whittling process, we will provide regular updates to keep clients abreast of any meaningful changes.
The American Families Plan comes on the heels of the American Jobs Plan, which was announced in March and focused on creating jobs through rebuilding the country's infrastructure. In contrast, the President's primary focus with the American Families Plan is on the needs of low to middle-income families by helping with the cost of child care and education. The White House has stated the American Families Plan is designed to be "an investment in our children and our families."
Some of the benefits of the plan:
It adds at least four years of free education by providing high-quality universal preschool to all three- and four-year-olds. It will also pay for two years of free community college.
Direct support so that families are not paying more than 7% of their income toward child care.
Increasing the Pell Grant program by $1,400 to help keep pace with the cost of a four-year education.
Extending through at least 2025, the changes to the Child Tax Credit including the higher $3,000 per child ($3,600 for children under six years old), full refundability, and prepayment to individuals.
Up to 12 weeks of paid parental, family, and personal illness leave (up to $4,000 a month), beginning with three days of paid bereavement time.
Additional funding for the IRS to step up tax law enforcement and help collect lost revenue by closing tax loopholes.
High-income earners will be paying for the plan's $1.8 trillion price tag, mainly through higher taxes or the elimination of existing tax loopholes in several areas. We will look at a brief overview of each of the three areas with the potential for change to the current tax code.
Elimination of cost basis step-up
One of the most significant changes proposed is eliminating the step-up in cost basis provided to heirs of inherited investment property. Currently, when someone passes away, there is a step-up in basis that allows the unrealized capital gains that have accrued over the holding period of the decedent to "reset" to the market value for the person inheriting the property. For example, suppose a person purchased stock ten years ago with a cost basis of $10 per share, and it is now worth $70 a share. When that person passes away, the cost basis of that stock resets to $70, effectively eliminating the $60 per share of built-in capital gains appreciation.
Under the new proposal, the original cost basis of $10 per share would carry over to the person inheriting the stock, providing no step-up benefit for capital gains purposes. Although there is a potential exclusion for capital gains less than $1 million (unknown at this time if that applies per person or household), the change is still significant and, if enacted, will require planning to avoid the potential tax implications to a person's estate.
Raising the top federal income tax bracket
Whereas the American Jobs Plan is being financed by increasing the corporate tax rate from 21% to 28%, the American Families Plan is paid for by increasing the top federal tax bracket from 37% to 39.6%, bringing it back to what it was before the Tax Cut and Jobs Act of 2017. The White House has stated this would affect only the top 1% of taxpayers. Additionally, the net investment income surtax of 3.8% would still apply for those earning $200,000 or more ($250,000 married filing jointly), bringing the total top tax rate to 43.4%.
Raising the maximum long-term capital gains tax rate
For taxpayers whose income is above $1 million, President Biden is proposing raising capital gains tax rates from the current 20% up to ordinary income tax rates, which can be as high as 39.6%, as previously mentioned. Further, for people above the $1 million threshold living in states that tax capital gains, such as New Jersey, the new top capital gains tax rate could potentially be as high as 54.2% when factoring in state-level taxation along with the net investment income surtax. Should this legislation pass in its current form, New Jersey would be the third-highest in the nation for capital gains tax rates, as shown by the Tax Foundation's graphic below.
It is important to reiterate that all the proposals are broad ideas and will likely look very different when finalized and ultimately passed through Congress. However, for clients approaching or above the income thresholds we are in the process of exploring planning opportunities through gifting, donations, income shifting, or capital gains harvesting.
Author’s Bio
Joseph Goldy, CFP®, is a wealth advisor and CERTIFIED FINANCIAL PLANNER™ at Highland Financial Advisors, LLC, a fee-only fiduciary wealth advisory firm based in Wayne, New Jersey.
Joe specializes in working with newly independent women because of divorce or losing a spouse. He understands firsthand the value of having a clear financial picture pre- and post-divorce and a plan to restate goals as a single person. When he is not helping clients, Joe enjoys spending time with his two sons outdoors and volunteering to help raise money for Type 1 diabetes organizations.