How to Prepare for (Potentially) Higher Taxes

By Levi Robinson

s interest rates have risen, it has become progressively more expensive to finance the federal deficit, so the urgency to address the US government debt burden has increased. Furthermore, personal tax rates are already scheduled to increase when the 2017 Tax Cuts and Jobs Act sunsets at the end of 2025. Congress will need to address this expiration of a wide range of personal tax provisions, but how these provisions are handled will depend on the outcome of the upcoming election and the makeup of Congress.

While it’s too early to know when taxes will rise, we suggest strategies to help manage future tax liabilities, regardless of the outcome of this year’s election.

It’s important to note that this list of proposed policies is not exhaustive.

President Joe Biden’s budget proposal for fiscal year 2025 aims to keep most of the income tax brackets intact but would seek an increase in the top income tax bracket from 37 percent up to 39.6 percent for income above $400,000 for single filers and $450,000 for joint filers.

In addition to increased income tax rates, Biden is proposing a more progressive investment tax structure that would tax capital gains and dividends as ordinary income for the wealthy. Currently, these taxes are mostly “flat” across the income spectrum, going from 0 to 15 percent for income above $47,025 and from 15 to 20 percent for incomes above $518,900.

These tax rates don’t include the Net Investment Income Tax, or NIIT, which is a surtax of 3.8 percent that kicks in for incomes of above $250,000 (under current law) for those who are married and file jointly. Biden has proposed raising the NIIT rate to 5 percent.

These proposals would mean that if ordinary tax rates increase to 39.6 percent, the capital gains and dividend tax could almost double from 23.8 to 44.6 percent (including the NIIT) for investors with taxable income over $1 million.

Under the current law, an individual can give away $13.61 million ($27.22 million for married couples) to others during their lifetime or at death without being subject to gift or estate taxes (which have a top tax rate of 40 percent for amounts over $1 million). Without congressional action, these amounts are set to continue to increase with inflation through 2025, after which they’ll decrease back to about $6.5 million per individual.

We expect Congress to address this expiring provision in 2025, but the outcome is uncertain. We anticipate that the size of the exemption will likely decline in 2026, though it might not revert to the $6.5 million threshold.

Such policy changes may also come with additional restrictions. Currently, investments that are transferred at death—except for qualified assets like retirement accounts and tax-deferred annuities—receive a “step-up” in cost basis. Biden has proposed repealing the “step-up” in cost basis upon death, taxing unrealized capital gains at death above a $5 million exemption ($10 million for joint filers).

If implemented, these changes would lead to a much larger tax being paid and would significantly hamper wealthy taxpayers’ ability to manage taxes when transferring wealth to their family.

Without carefully developing a tax strategy, investors run the risk of missing out on key tax benefits and paying more in taxes than necessary. However, with so many variables that factor into an individual’s tax liability, it can be difficult to determine what the right tax strategy looks like.

1. Savings Diversification

Ideally, you will be able to diversify your savings across a mix of different account types (taxable, tax-deferred, and tax exempt) so that you can draw from your retirement funds in whichever sequence is most tax-efficient year to year.

2. Dynamic Withdrawal Strategy

The income tax system is progressive. As a result, holding the bulk of your wealth in tax-deferred accounts could create a “tax time bomb” for your retirement years, when you will be taxed on distributions from those accounts.

We recommend a dynamic withdrawal strategy that distributes enough from your tax-deferred accounts to fill up your tax bracket each year in retirement.

3. Defer Capital Gains When It Makes Sense

Even if you’re sure that capital gains tax rates will go higher in the future, that doesn’t necessarily mean that you’ll be better off realizing capital gains now to lock in today’s long-term capital gains tax rate of 23.8 percent. That’s because the dollars that you would have to give to tax authorities would no longer be growing in your account.

4. Increase After-tax Growth with “Asset Location”

Asset location is the strategy of allocating the right investments (stocks, bonds, etc.) in the right accounts (taxable, tax-deferred, tax-exempt). In our view, this can help to boost your family’s after-tax growth potential, especially by holding high-income and high-turnover investments in tax-advantaged accounts where they will not produce a “tax drag” on returns.

5. Revisit Your Estate Plan and Consider Accelerating Lifetime Gifting

Looming reductions to the lifetime gift and estate tax exemption create a “use-it-or-lose-it” opportunity to potentially save millions in estate taxes. Strategic lifetime gifting is imperative if you want to protect your assets— and their appreciation—from being included in your taxable estate.

6. Give to Others and Grow

Donor advised funds, private foundations, and some trusts can offer the potential to make gifts out of your taxable estate today and grow those assets for years or decades before ultimately disbursing your gift—and any gains—to charities and other nonprofit organizations.

Tax management strategies are best done very carefully, and it can take time to organize things properly. When it comes to tax planning ahead of the election this year, it’s important to take a more proactive approach, rather than a reactive one, to make sure you don’t miss out on any last-minute tax savings opportunities and to increase the likelihood of reaching favorable outcomes even when the circumstances are out of your control.