1. Raising the Capital Gains Tax Rate on High Income Earners
To help finance the $1.8 trillion American Families Plan, the Biden Administration has released some details on increasing the tax rate on long-term capital gains from the current 20% top rate.
The plan would tax capital gains and qualified dividends as ordinary income, topping out at 39.6% if the current version becomes law. Under the proposal, the higher capital gains tax rate would apply to those with an annual income above $1 million. When combined with the existing Medicare surtax, the top long-term rate on capital gains would swell to 43.4%.
2. Repeal of the Step-Up in Basis
The Administration’s tax plan calls to repeal the step-up in basis, which permits an individual’s heirs to use the fair market value of assets at the time of inheritance rather than the original cost to the descendant. This means any appreciation prior to the decedent’s passing would become taxable.
3. Elimination of 1031 or “Like-Kind” Exchanges
Like-kind exchanges allow real estate investors to defer paying capital gains tax upon the sale of a property when those proceeds are used to purchase another property. The Administration’s tax plan seeks to remove such deferrals for gains that exceed $500,000.
4. Retroactive Rates are Possible
Higher tax rates could be implemented retroactively, to the beginning of 2021 or the date at which they are passed into law. Based on historical review, such retroactive measures have most often applied to rate decreases, which are easier to implement.
5. Congress May Balk, But the Prospects for a Hike are Gaining Significant Traction
There is no certainty that the Administration’s tax proposals will find sufficient traction in Congress to become law. And there will certainly be an ongoing debate and possibly negotiations to find a middle ground. What is clear, however, is that raising taxes on corporations and the wealthy has broad popular support, and the capital gains tax is low-hanging fruit. We believe there is a strong likelihood of a substantial increase in capital gains tax rates.
Change is Coming, Prepare Now
The hunt for acquisitions is intensifying, given an overhang of approximately $2 trillion of dry powder sitting in PE funds, corporate balance sheets that are swollen with cash, and equity values nearing all-time highs. Business valuations and sale prices are holding up well, with current multiples at or near the same lofty heights reached prior to COVID-19.
Owners of privately held businesses must weigh the advantages of cashing out now—when taxes are low and valuation multiples are high—versus staying the course, possibly reaping the benefits of a strong economy despite the prospects of substantially higher personal and corporate tax rates down the road.
One way or another, change is coming. It’s important to arm yourself with the facts, understand your options, and be prepared to act to optimize the outcome for your particular situation. For nearly 40 years, Berkery Noyes has been advising owners of privately held businesses on exactly these kinds of decisions, providing thoughtful, unbiased, and informed guidance to our clients. We invite you to contact us today for a confidential discussion (without cost or obligation) of your options.