The Taxman
September 24, 2021

The Taxman

by Kathryn Haggitt Fisher

In the first lines of “Taxman” from their 1966 album, Revolver, the Beatles promised to “tell you how it will be…one for you, nineteen for me.” No one is proposing a 95% tax rate, and exactly how it will be is still uncertain, but increases are imminent at both the state and federal levels. A new capital gains tax was passed by the Washington state legislature, effective January 2022, with the first taxes due in April of 2023 – although the state Supreme Court is expected to hear legal challenges to the law. And, as you’ve likely heard, the House Ways & Means Committee has provided initial legislative recommendations which contain elements of President Biden’s Build Back Better agenda. Let’s take a closer look at the state capital gains tax and some of the recommendations from the Ways & Means Committee.

Taxes at the State Level

We’ll start with the Washington state capital gains tax, which was passed into law on May 4, 2021. In short, the law enacted a 7% tax on sale of long-term capital gains. It is important to note that the tax applies only to gains over $250,000 each year, and excludes real estate, assets in retirement accounts, and interests in qualified family-owned small businesses. Also excluded are certain livestock, timber and timberland, commercial fishing privileges, and goodwill received from the sale of auto dealerships. The $250,000 deduction applies whether you file as an individual or married couple, and charitable donations in excess of $250,000 can be deducted up to $100,000 per taxpayer. The first taxes owed as a result of the new law would have a due date of April 17, 2023.

Non-grantor trusts (i.e. those with their own tax ID number) would not be subject to the state capital gains tax, but gains in grantor trusts and non-grantor trusts includible in the grantor’s estate (incomplete non-grantor trusts) would be taxable to the grantor.

There is a provision in the bill that designates the tax as “necessary for the support of the state government and its existing public institutions” which means the law is likely exempt from the voter referendum process, but could be subject to a voter initiative, which faces more stringent requirements for getting on the ballot. There are legal challenges to the law’s constitutionality, but it could take considerable time before the state Supreme Court reaches a final decision.

For taxpayers who regularly realize more than $250,000 in capital gains, a change in your state of residency could avoid the gains tax. Accelerating capital gains into 2021, thereby lowering gains after the tax takes effect, may also help reduce gains for 2022 and forward. Gifting assets with high capital gains directly to charity, into charitable trusts, or to non-charitable beneficiaries subject to lower tax brackets are additional ways to avoid or minimize the tax.

Taxes at the Federal Level

While significantly different from President Biden’s initial proposals under the Build Back Better Act, the recommendations from the House Ways & Means committee are estimated to raise taxes on wealthy individuals and corporations by about $2.1 trillion over 10 years. Roughly $1.2 trillion of that would go towards reducing taxes for low- and middle- income households, with the remaining $900 billion going towards domestic spending.

The draft from the Ways & Means Committee may be modified by the House Rules Committee before it moves to the House floor for a vote – and then it may undergo additional changes before the Senate agrees to it. The key components affecting individuals are outlined below, but we want to emphasize that all of this is subject to change. As currently proposed, the Build Back Better Act would:

  • Increase the top ordinary income tax rate from 37% to 39.6%, effective January 1, 2022.
  • Lower the estate tax exemption from $11.7 million to $6 million, effective January 2022. (Gifts can still be made through the end of 2021 at the current $11.7 million exemption amount.)
  • Increase the capital gains rate from 20% to 25% for high income taxpayers (HITs: filers who are married filing jointly with modified adjusted gross income (MAGI) of $450,000 or greater or single filers with $400,000 of income or more) effective as of September 13, 2021.
  • Impose a 3% surtax on income over $5 million, effective January 1, 2022.
  • Eliminate IRA contributions for HITs whose total IRA assets exceed $10 million.
  • Require HITs to distribute 50% of the amount over $10 million held in IRAs. More significant distributions would be required for taxpayers with IRA assets over $20 million.
  • Limit Roth IRA conversions based on income thresholds.
  • Disallow certain investments in IRAs.
  • Increase the corporate tax rate from 21% to 26.5%.

Some notable elements of the Biden plan not included in the recommendations of the Ways & Means Committee include:

  • The elimination of step up at death
  • Tax on unrealized gains at death
  • Relief for state and local taxes in the form of deductions at the federal level (although Ways & Means Committee Chairman Neal has said that needs to be included)
We will continue to keep you apprised of developments at both the state and federal level. If you have questions regarding how these changes affect you directly, please contact your Fulcrum advisor. We can help determine what steps, if any, you should take to mitigate the impact of tax reform on your financial plan.
While the information above is obtained from reliable sources, we do not guarantee its accuracy. Information discussed is not intended to supply insurance, tax, or legal advice. This information is subject to change without notice. Fulcrum Capital, LLC is an SEC registered investment adviser with its principal place of business in the state of Washington. For additional information about Fulcrum Capital please request our disclosure brochure using the contact information above.
Search our blog
Relationships are our most important investment.
Connect with a skilled advisor.