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How the wealthy put together for larger taxes

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To pay for a historic and comprehensive social safety net expansion, President Joe Biden and the Democrats plan to hit wealthy Americans with higher taxes.

In response, financial advisors and their wealthy clients are also making plans. In particular, they are looking for steps they can take now to avoid some of those steeper levies later.

Some of the changes to the tax law that may be emerging soon include: A new 3% surcharge for those earning more than $ 5 million; an increase in the top tax rate to 39.6% from 37% for those with a household income of more than $ 450,000 and for those with an income of more than $ 400,000; and an increase in the capital gains rate, which applies to assets such as stocks and real estate, from 20% to 25%.

More from the FA playbook:

Here’s a look at other stories that are affecting the financial advisor business.

Consultants say many customers breathe a sigh of relief at the latest suggestions. Biden had called for the capital gains ratio to be increased to 39.6%.

Nevertheless, many fear a higher tax burden.

“Our customers are concerned,” said Michael Nathanson, CEO and chairman of The Colony Group, a Boston-based consulting firm that works with high net worth individuals. “This would be one of the biggest tax hikes in history.”

Here are some of the measures that are triggering these worries.

Prepare for higher taxes

Nathanson recommends certain customers increase their income this year before higher interest rates go into effect.

For example, if a person sells a business, they could try to close the deal by the end of the year, Nathanson said. Those who receive high job bonuses can try to negotiate a way to get the money before 2022.

Ordinarily, he would also try to maximize future deductions to bypass the new 3% surcharge for customers with incomes greater than $ 5 million, but that won’t work in this case because the tax is on adjusted gross income income is based and not subject to tax.

“Adjusted gross income is calculated before the individual deductions are taken into account, so customary deductions such as charitable donations and mortgage interest will not affect the proposed new addition,” he said.

To avoid customers being hit by a higher marginal income tax rate in the next year, Mallon FitzPatrick, Managing Director and Principal at Robertson Stephens in San Francisco, advises donating an income-generating asset, such as property, to a family member falling into the crisis consider a lower bracket.

“The giver reduces the taxable income and the recipient pays a lower tax rate on the income from the asset,” said FitzPatrick, a certified financial planner who works with clients with a net worth of $ 10 million or more.

Another way to report lower taxable income next year would be to defer some of your charitable donations – and the deductions they bring you – until 2022, FitzPatrick said.

“Nonprofit income tax deductions are more valuable in an environment with higher income tax rates,” he added.

Moving forward to a higher rate of return on capital

Wealthier individuals have limited preparation for what is likely to be a higher return on capital ratio in the future.

That’s because policy makers have suggested that the increase be retroactive to September 13th of this year.

Still, experts say investors have options.

This would be one of the biggest tax hikes in history.

Michael Nathanson

CEO and Chairman of the Colony Group

FitzPatrick said individuals can differentiate their capital losses until next year, which would offset their profits if the tax rate could be 25% instead of the current long-term tax rate of 20%. (If your profit is $ 10,000 but you’ve lost $ 5,000, your net profit is only $ 5,000.)

“Next year, all of my capital gains may be capped at 25%,” said FitzPatrick. “So my losses, which I can offset against my winnings, will be more valuable in the next year.”

Before the inheritance tax ensnared even more people

Legislators are also proposing to reduce the inheritance and lifelong gift exclusion from the current $ 11.7 million to about $ 6 million, meaning more people will be affected by inheritance tax of up to 40%.

As a result, advisors say they’ll tell clients considering lifelong asset transfers to do so before the end of 2021.

There are a number of ways you can go about this, FitzPatrick said.

You can give the gift directly, which means that you give control of the assets to the recipient. The other option is to use an irrevocable trust.

Some trusts also give up power over the assets – and with it inheritance tax liability – but you may still be able to put some controls on how the funds are distributed, FitzPatrick said. For example, you might not want a child to have income from it until they are 25 years old.

“This will help protect against a quick exhaustion of trust,” said FitzPatrick. “After the death of the original beneficiary, their children become beneficiaries and so on. [It] preserves wealth for future generations. “

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