Taxes. Just that word might make you want to look away and not read any further. But as we turn the page into a new presidential administration and past 2020, I urge you to read about some things that could possibly affect you and your family as tax laws may change.
First, there are many tax proposals affecting families, businesses, social security, retirement plans, etc. I'd like to stick to three that could affect more of us. Before we dive on in: Nothing is set in stone, and none of the proposals have become policy. The pandemic will put a hold on these for some time, but I wouldn't be surprised if some of these become law by late 2021 into 2022. On top of that, there's a chance they could retroactively put them in place for the 2021 calendar year. Let's hope that doesn't happen.
Current Law: Upon someone's death, all property is stepped up in value. Meaning, at the date of death, the cost basis "steps up" to the fair market value on the date of death or six months after. Meaning, no capital gains tax needs to be paid by those inheriting tangible property, stocks, anything that has appreciated in value. This is a great tool to pass wealth onto heirs/beneficiaries as they inherit stocks or property without having to pay taxes. If there's any appreciation on it after the step up in value, they'll have to pay taxes on the gains.
Example: XYZ stock was bought by your parents for $20. They pass away while still holding this inside their trust and it has appreciated to $100. When you inherit XYZ stock for $100, you don't owe any taxes on the appreciation of $80. If they sell it for $120, you'll owe taxes on $20 because the new basis is $100. Same goes for real estate!
Proposed Change: No step up in basis. Heirs will have to pay capital gains if they were to sell property, stocks, etc. using the cost basis that was used to originally purchase the asset. Capital gains are based upon your income levels. For the majority of us, you'll pay 15-20% if you are to sell something that has a capital gain.
Example: XYZ stock was bought by your parents for $20. They pass away while still holding this inside their trust and it has appreciated to $100. You inherit XYZ stock. If you were to sell the stock for $100, you would owe taxes on the $80 of appreciation. Again, this is based upon your income. From most of us, it will be a 15-20% tax.
Payroll Taxes - Social Security Taxes
Current Law: For most of us, we split 15.3% with our employer of what is known as payroll tax. This pays for future social security and Medicare for us as we enter retirement. We pay 7.65%, and employers pay the other half. This is capped at income levels up to $142,800 for 2021. Above that income, you are not taxed payroll tax. If you are self-employed, you pay 15.3%!
Proposed Change: The same law exists. However, if you make more than $400,000 as an individual, you are taxed 12.4%, which is split evenly between your employer and yourself. You'll pay 6.2%. Again, income earned between $142,800 and $400,000 is not subject to payroll tax. You're still going to be paying federal income tax and state income tax!
Capital Gains Tax
I've heard people talk about how capital gains taxes are going up for all of us to our income tax levels. For the vast majority, this is not true. Capital gains taxes are based upon income levels. For many of us, our capital gains taxes will be 15%-20%, as they have been. If your income is over $1,000,000, your capital gains tax is proposed to increase to 39.6%
Example: You buy XYZ stock for $20 in a taxable investment account. It appreciates to $100. You will owe taxes on the $80 of appreciation. If you're married earning under $500,000, your taxes on your gain will be $12 as you're taxed at 15%. If you're earning over $501,000, you're taxed at 20% and your tax bill would be $16.
REMEMBER: Short term capital gains are taxed at your income tax rates. This is when you hold something for one year or less! Hold for 366 days to avoid the heightened tax.
Side note regarding your home: For a married couple, if you sell your primary residence, you're still able to exclude up to $500,000 of capital gains! This will not change.
Ultimately, talk to your tax professional and financial advisor about your current situation and how it can impact you. Remember, if you just get your taxes done once per year through a tax professional, they're not necessarily helping you with tax planning! Coupled with proper investment and strategic planning, tax planning can make big impacts over time. If you can get the little things right year after year in these two areas, you'll see your actions compound in the long run.
Chris Gervat is a Financial Advisor at Lifeworks Advisors, a multigenerational team that provides wealth management services and strategic advising to successful families, businesses, and entrepreneurs. Learn more at lifeworksadvisors.com.