June 14, 2024
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June 14, 2024
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Positioning Your Wealth for Higher Taxes

Benjamin Franklin famously stated that “in this world, nothing is certain except death and taxes.” While the United States has enjoyed low taxes in many areas of the economy for decades, stimulative fiscal policy is unlikely able to persist. Therefore, it is challenging to envision a scenario that does not involve future tax hikes.

There are two primary mechanisms to reducing the U.S. fiscal deficit: cutting spending or raising taxes, both of which are largely unpopular. Either approach would likely have negative impacts on the economy in the short-term, making them highly politicized. And considering that we are in an election year, any drastic effort to reduce the federal deficit in 2024 is highly improbable.

Regardless of the political leadership come November, meaningful tax increases appear more likely in the future than spending cuts for the following reasons:

  1. With inflation failing to drop to the Fed’s objective of 2%, interest rates are likely to remain elevated. Therefore, the government’s interest expense for its accumulated deficits may continue to grow, at least until inflation is sustainably within the Fed’s inflation target.
  2. As the baby boomer generation continues entering retirement, Social Security and Medicare spending should continue to rise.
  3. With growing geopolitical unrest, the U.S. defense budget may continue escalating over time.

Without material spending cuts, the only option to reducing our fiscal deficit is by increasing taxes. To help gauge some of the possibilities of future tax policy, it is worthwhile to look at the TCJA (Tax Cuts and Jobs Act) which is expected to sunset at the end of 2025. Additional clues may be found in President Biden’s proposed tax budget for 2025.


Tax Cuts and Jobs Act

The Tax Cuts and Jobs Act (TCJA) was passed in 2017 to reduce overall taxes for both individuals and corporations. Some of the features included lowering corporate taxes, reducing personal tax brackets, increasing the standard deduction and child tax credits, raising the federal estate tax exemption, and increasing the threshold for the Alternative Minimum Tax. While certain components were made permanent, including the reduction in corporate taxes, many individual tax benefits are set to expire at the end of 2025.


2025 Budget Proposal

Without speculating on the outcome of the presidential and congressional elections, it is worthwhile to note the tax plan of the current administration. The current President has unequivocally expressed his position to raise taxes on the wealthy. Of the TCJA, he recently voiced that “it’s going to expire, and if I’m reelected it’s going to stay expired.”

In the president’s 2025 budget proposal, there are some new key areas that should be noted. On the corporate side, the proposal outlines an increase in corporate taxes, including the corporate tax rate (from 21% to 28%) while increasing taxes on share buybacks. If enacted, these increased taxes are likely to have implications on corporate profits and equity prices. On the individual side, most of the new tax revenue will be aimed at those with significant assets or income. Examples include raising the highest marginal tax bracket from 37% to 39.6% for those making $400,000 (for single filers) or $450,000 (for joint filers) and raising the capital gains tax to ordinary tax brackets for those with income over $1,000,000.


Wealth Planning Strategies For an Increase in Tax Rates

Without going into detail about the broad implications of the potential sunsetting of the TCJA or 2025 fiscal budget, there are certain wealth planning techniques to take into consideration.

If one expects higher future income tax levels, a Roth Conversion might be something to consider. Put simply, a Roth Conversion allows one to transfer a traditional retirement account into a Roth account. The Roth account then grows tax-free, giving the owner flexibility to manage its distributions on their own timeline while passing the remaining assets to their heirs without tax implications. While one does pay income taxes on the funds converted that year, this planning strategy is generally beneficial to those expecting to be in a higher future tax bracket.

In 2024, the amount for the federal estate tax exemption is $13.6 million for individuals and $27.2 million for couples. Any amount above these levels is subject to a 40% federal tax rate at passing. If the TCJA sunsets, the exemption amounts will revert to pre-TCJA levels (around half plus an inflation adjustment) so the number of households subject to the federal estate tax will dramatically increase. For those with an increased probability of exceeding the new estimated threshold, it is essential to review one’s estate plan well in advance of the sunset. Why? There are various planning strategies one can employ before 2026 that would minimize the impact of the sharp reduction in the estate tax exemption.

Given that the future tax code is uncertain, the placement of one’s assets in the proper account vehicles should be examined to meet one’s objectives. For example, if one has both retirement and taxable accounts and individual tax brackets rise from today’s level, it becomes more compelling to place lower return, higher yielding assets (i.e. bonds) in tax-deferred accounts for those nearing the age of RMD’s. This helps shelter taxable interest income from higher tax rates. Moreover, capital gains in the taxable account can be better managed in a tax efficient way.

One caveat, however, is that the reverse could be true for younger investors. Since equity returns have historically outperformed fixed income returns, it may be more advantageous to overweight equities in one’s tax-deferred account. Additionally, as taxable accounts are more often used for spending flexibility, minimizing portfolio volatility with lower risk investments (i.e. bonds) is often preferable.

Looking at the Big Picture

Predicting future tax rates is fraught with uncertainty, especially over the longer-term. Therefore, instead of trying to “beat” Uncle Sam through savvy wealth strategies on a standalone basis, it is prudent to look at investment, tax, and estate planning strategies in the context of one’s entire financial picture. To do so, one should begin with a broad financial plan that accounts for income, expenses, assets, current and future liabilities, risk tolerance, time horizon, and overall objectives. From there, one can build and execute the necessary strategies to improve the probability of maximizing one’s goals.

Joseph Caplan is a vice president of investment strategy at Caplan Capital Management. He received his BA in economics from Rutgers University.

 Investment Advisory Services are offered through Mariner Independent Advisor Network (MIAN), an SEC Registered Investment Adviser. Caplan Capital and MIAN are not affiliated entities. Some information provided herein has been obtained from third party sources deemed to be reliable as of the date of original publication, and rules, laws and legislation are subject to change without notice. This article is for educational purposes only and should not be considered personalized advice, and it is important that your unique circumstances be taken into consideration prior to making any financial decisions. There is no assurance that any investment, plan, or strategy will be successful. Investing involves risk, including the possible loss of principal.

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