Financial advisers and their clients have been bracing for higher taxes ever since Democrats won the White House and took over Congress in last year’s election after promising to make the wealthy pay more.
Those fears ramped up over the spring and summer, then reached their peak earlier this fall as Democrats haggled over tax increases that would fund a massive social and climate spending measure now known as the Build Back Better Act.
Edgy clients were ready to make major financial decisions to take advantage of the current low-tax environment before Congress made changes. For instance, one of Paul Auslander’s clients wanted to make a big gift to one of his children under the current estate tax individual exemption of $11.7 million before it was lowered to about $6 million by the pending bill.
The problem was that the legislation hadn’t been approved by the House, let alone the Senate. Auslander counseled patience on a multimillion-dollar gift that the client wouldn’t have been able to retract.
“What happens if the tax law doesn’t come to pass?” Auslander, director of financial planning at ProVise Management Group, asked the client. “You’re giving [your assets] to your son who is married to a woman you hate.”
A few weeks later, Auslander’s caution proved to be prescient.
Reducing the estate tax exemption is one of many tax provisions — including hiking individual and capital gains taxes for high earners — that fell out of the nearly $2 trillion Build Back Better bill the House approved Nov. 19.
“Your foremost responsibility is to do no harm,” Auslander said. “Had planners jumped the gun and moved ahead with these strategies, they might be very well regretting them now.”
Many advisers are telling clients to wait until the smoke clears on Capitol Hill before making major tax planning decisions.
“Every day, every week, there could be more clarity,” said Bruce Weininger, principal at Kovitz Investment Group.
His clients are counting on him to stay on top of what is happening in Washington, said Rob Kuharic, director of tax managed solutions at Russell Investments. When he provides updates, he dispenses them with a grain of salt.
“Realize that none of this is written in stone,” Kuharic said. “Everything is written in pencil right now. It can change at the last minute.”
The Build Back Better legislation is far from the finish line. As it goes to the Senate, Democratic leaders and the Biden administration have to convince all 50 Democrats to back the bill under parliamentary rules that sidestep a Republican filibuster in the chamber.
A tug of war is likely to continue between moderate Democrats who want to limit tax increases and the progressive wing of the party that is pushing additional tax increases to meet their goal of ensuring the wealthy pay their fair share.
Many clients are following the swirling potential tax increases as they rise and fall in probability, and worrying that they should be making moves with their portfolios and estates before it’s too late. But amid the vicissitudes of the legislative process, what looks like a sure tax hike one day can dissipate into the political ether the next.
“You can look very foolish if you pull the trigger on something too soon,” said Mike Repak, vice president and senior estate planner at Janney Montgomery Scott. “You can cost your clients money. People want to react fast. But sometimes it’s a good idea to wait until you know exactly what’s going to be enacted into law.”
One of the most popular moves when tax increases are on the horizon is to do a Roth conversion, taking tax-deferred money out of a traditional individual retirement account, paying taxes and then moving the money into a Roth IRA, where it can grow and later be withdrawn tax-free.
Roth conversions seemed like a great idea when raising the top individual rate was included in a previous version of the Build Back Better legislation. Now that idea appears to be off the table thanks to resistance from moderate Senate Democrats.
“Roth conversions may still be a good strategy, but doing it just because of a potential tax increase may have been a bit shortsighted,” said Tim Steffen, director of tax planning at Robert W. Baird & Co. “People who rushed to do Roth conversions earlier this year may have buyer’s regret.”
Trying to keep clients calm about the possibility of a higher tax bill is a challenge for advisers.
“Taxes are a different thing,” Steffen said. “They really get at people psychologically. There’s something about taxes that makes people overreact.”
One challenge for advisers is to prevent clients from making snap decisions depending on the latest update they’ve heard on the news.
“What is more important is the broader, long-term picture,” said Alyson Nickse, a partner at Crestwood Advisors. “That is where planning is really important.”
Clients have breathed a sigh of relief about the trajectory of many of the tax changes that worried them most, such as a proposal to end the so-called step-up-in-basis and tax unrealized capital gains at death. That idea never made it into even the initial Build Back Better draft due to bipartisan concern about small businesses and family farms. Top individual rates also seem to be stable.
Nonetheless, the debate over raising taxes is catalyzing conversations between advisers and clients.
“Even if we dodged the bullet, taxes aren’t going to 0.0%,” Kuharic said. “We’re using the uncertainty to focus on tax planning.”
Advisers are discussing with clients how and when they want to make major financial decisions that can trigger substantial tax consequences.
When the possibility of doubling the capital gains tax for high earners seemed as if it was a lock to be included in the Build Back Better bill, that focused the minds of small-business owners on the future of their operations — even if the pressure to sell dissipated once the threat of a capital gains tax hike receded.
“Maybe they might [sell] someday, so let’s do the things we need to do with your business to be prepared to sell,” Auslander said. “This is a huge opportunity for financial planners to show their worth.”
Even though the estate tax exemption has been untouched so far, the fact that it was part of legislative deliberations has spurred clients to grapple with the reality that it is scheduled to reset to a substantially lower level in 2026. They’re considering making gifts now.
“It’s still worthwhile to look into it,” said Richard Pon, a financial planner and CPA in San Francisco. “I’m telling people to do that planning right now. You know [the decline in the exemption] is going to happen in 2026.”
The possibility that a reduction in the estate tax exemption would be used to help pay for the Build Back Better bill has allowed Weininger initiate conversations with clients about gifting that he said otherwise might have been put off for another two or three years.
“It’s going to be use it or lose it,” Weininger said. “There are advantages to doing it now if you can get comfortable that in the worst-case scenario you won’t need those assets.”
For clients who want to gift now, Luke Harriman, a principal at the law firm Much Shelist, often recommends a spousal lifetime access trust. Although the money given to a spouse is irrevocable, the funds are still in control of the spouses rather than being transferred to the couple’s children.
“We have been trying to stick to strategies that will have as much flexibility as possible and work in multiple different environments,” Harriman said.
As potential tax changes continue to swirl around Capitol Hill, advisers stressed that trying to gain a tax advantage shouldn’t be the primary motivation of a financial decision like gifting.
“Don’t rush and make multimillion-dollar transfers that you’ll regret later when they don’t change the laws,” said David Handler, partner at law firm Kirkland & Ellis. “If you’re not happy giving them away, don’t do it. That’s your answer.”
Standing pat and waiting to see what tax changes finally make it to President Biden’s desk is the best advice for most clients.
“It might cost a couple bucks, but at least we’ll go at it in a thoughtful way,” Auslander said.
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