Wealth Managers And Their Clients Wait Nervously For The Tax Hikes That Will Finance Democrats’ $3.5 Trillion Spending Plan

(Forbes) - With the recent Senate passage of a $1.2 trillion bipartisan infrastructure deal, attention is shifting to a massive $3.5 trillion “human infrastructure” package set to be passed by Democrats alone through the budget reconciliation process.

Whereas the infrastructure deal contained just a few controversial pay fors—burdensome new tax reporting for the crypto industry and an early end to the Employee Retention Credit —financial advisors and others in wealth management are bracing themselves for tax hikes on the wealthy that President Joe Biden and Congressional Democrats have said will help pay for their economic agenda. While the ultimate shape of those changes is still unclear, advisors are working with clients to assuage fears and, to the extent possible, prepare them for the most likely tax hits.

Spuds Powell, a Forbes/SHOOK top advisor and managing director at Kayne Anderson Rudnick, says that taxes have been a hot topic for months with clients yet the firm has preached patience. The political picture has been a large part of the discussion, with Democrats holding unified control of Washington, D.C., albeit with a very slim majority in the House of Representatives and an even closer 50-50 split in the Senate.

Powell, whose Los Angeles-based RIA manages $39.6 billion for clients, expects there will be tax increases of some sort but thinks they will not rise to the level discussed during the Democratic primary election. While he foresees capital gains tax rates going up, he is wary of telling clients to make major moves to try to get out in front of the increase, given the danger they’ll lose out on potential market gains and then face possibly retroactive tax hikes anyway.

“It’s common for people to make the mistake of being so focused on either minimizing or avoiding taxes, that they end up making decisions that compromise their investment portfolio,” Powell says. “I remind those same people who are concerned about taxes and inclined to make silly decisions about their investment strategy in order to reduce taxes, that the best way to avoid investment related taxes is to put all their money in a shoe box and keep it under the bed.”

“I try to help people avoid making the mistake of letting the tax tail wag the investment dog,” he adds. “I've always felt that the greatest mistake investors can make is letting their emotions influence their judgment when it comes to investment decisions. And the worst of all emotions would be fear.”

Matt Sommer, a senior managing director with $350 billion asset management shop Janus Henderson, says it is still too early to advise on specifics when it comes to a client’s tax situation. However, there is still value in preparation. One specific area he is watching is the repeal of step-up, a major tax benefit that incentivizes wealthy individuals to hold on to highly appreciated assets until they die, at which point their assets get a step-up in basis to their current market value. In other words, their heirs can sell without paying gains taxes.

He is also looking at provisions that would make inheritance of appreciated property a deemed sale, creating an immediate capital gains tax bill even if heirs don’t want to sell. There’s also the possibility that the amount excluded from estate taxes, which was temporarily doubled from $5 million to $10 million per person by the 2017 Tax Cuts and Jobs Act, could be reduced before its scheduled expiration in 2026. With inflation adjustments, the 2021 exemption from estate and gift taxes comes to $11.7 million per person.

Even with significant uncertainty, Sommer says that estate planning attorneys were as busy as ever in 2020 with clients getting started on drafting trusts in the event of tax changes.

Among the prospects that Sommer is looking at is a rise in the highest tax rate on ordinary income, from 37% to a previously proposed 39.6%, which could make Roth 401ks and IRAs more attractive. Additionally, charitable gifting could see added interest.

Sommer’s focus is chiefly on the aforementioned increase in the highest tax rate, long term capital gains changes for those who make more than a million dollars, and the change to step-up.

Alvina Lo, chief wealth strategist at Delaware-based Wilmington Trust, says that it has always been a matter of when and how much, not if taxes are going to change.

While the general areas of potential change, including changes to the capital gains rate, the top marginal tax rate and step-up are known, with tax planning the devil is in the details, points out Lo. Her team at Wilmington Trust, which manages some $17.5 billion in client assets, is cautioning against knee jerk reactions like selling to evade capital gains tax hikes, but is also counseling clients to be open-minded to taking some risk off the table in a targeted manner. She also says they are recommending gifting, though that is a carry over from advice prior to all this tax change frenzy because of the firm’s view that the tax environment in the aftermath of the 2017 tax bill was the friendliest to wealthy clients it was ever going to get.

Lo says her team is working with attorneys and other professionals to be proactive in making plans that can be quickly executed upon passage of new legislation. While much anxiety will accompany the final bill and revelation of the tax changes contained within, Lo says there could also be some sense of relief in the added certainty as well as the likelihood that once the smoke clears the reality will pale in comparison to the doomsday tax scenarios investors have seen pushed by the likes of Elizabeth Warren and Bernie Sanders.

By Jason Bisnoff - Forbes Staff
A wealth management staff writer at Forbes


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