President Biden’s long-signaled capital gains tax proposal could be the tinder that sparks another surge of RIA dealmaking — and may prompt advisors themselves to overhaul how they manage their core clients.
The Biden plan proposes raising the top tax rate on long-term capital gains to 39.6% from 20% for people earning over $1m. When combined with the existing federal surtax on investment income and state taxes, the proposal could mean high earners in New York and California give up more than 50% of their capital gains to taxes.
Karl Heckenberg, chief executive of RIA minority investors Emigrant Partners and Fiduciary Network, told Citywire he was skeptical the proposed hike on high-earners would actually come to pass. But said that any increase in capital gains taxes would eat away at the proceeds an advisor brings in from selling their business.
‘I think it’s sending shockwaves through RIA sellers as a strong reminder [that] now is the time to sell or sell a stake if they were considering doing so over the next two to five years,’ he said. ‘Even a 50% increase in capital gains makes a huge difference in net proceeds. I think we will see a number of deals brought forward into 2021 that might have been done in 2022/23 due to the proposed changes in capital gains and ordinary income rates.’
Heckenberg said he also expected interest among investors for tax planning services to surge and that advisors may need to rethink how they construct their clients’ portfolios.
‘Advisors focusing on mutual funds will need to seriously look at unified managed accounts and other more tax-efficient ways of participating in the equity markets. Expected public equity returns are forecasted to be lower so higher taxes and higher fees will be a big drag,’ he said.
The same dynamic which could affect RIA sellers also affects some of their most common mass-affluent clients: small business owners. Those proprietors may bring in far less than $1m annually, but if they choose to sell their business, the one-time windfall they receive could push them into a higher capital gains tax bracket.
‘One thing that I have repeatedly encouraged individuals to realize is this isn’t just a crazy rich people problem,’ said Jeff Levine, chief planning officer at $55bn Buckingham Wealth Partners. ‘No doubt, to get to a million dollars of income, you’re doing really well. But it doesn’t mean you’re doing-a-million-dollars-of-income-every-year well. There’s a big difference there.’
What workarounds can advisors create? Levine told Citywire that he expects any vehicle that can defer tax liabilities to start looking attractive. Traditional individual retirement accounts (IRAs) allow investors to stash away money tax-free, with gains only being taxed upon distribution.
‘Without a doubt, this creates a significant increase in the incentives to use a retirement account,’ said Levine.