Advisers blast Biden's retroactive capital gains proposal

The sale of a business or a major piece of real estate could take years to plan and execute, but if the transaction took place in May or will occur later this year, the owner could face a big capital gains tax bill under a proposal from President Joe Biden.

The Biden administration would raise capital gains taxes from about 23% to 40.8% for households making more than $1 million annually. The higher rate would help fund the American Families Plan, a $1.8 trillion package of spending on childcare, education and other social programs.

The effective date for the capital gains hike would be April 28, 2021, when the American Families plan was introduced, according to the Treasury Department’s Greenbook, a compendium of revenue proposals for fiscal 2022 that was released with Biden’s $6 trillion budget proposal on May 28.

The capital gains proposal is among several tax increases on high-earners included in Biden’s budget, which must gain congressional approval. During the legislative process, the effective date for the capital gains proposal — and the rate — might change or the tax increases could be scuttled.  

But for now, the notion of a backward-looking effective date, which would prevent the acceleration of capital gains to beat the pending higher rate, is not sitting well with investment advisers.

“Sometimes selling a business can take years,” said Devin Pope, a senior wealth adviser at Albion Financial Group. “People plan their retirement life around the after-tax proceeds they would receive from a liquidity event. Changing the rules in the third quarter of the game doesn’t seem fair. The government should allow people to plan around significant tax law changes such as this.”

Most other Biden tax proposals — such as raising the highest ordinary income tax rate and ending step-up basis by imposing a capital gains tax on appreciate of more than $1 million in inherited assets — have an effective date of Jan. 1, 2022.

That would have been an appropriate time for the start of the capital gains increase, said Dan Herron, principal at Elemental Wealth Advisors.

“You can’t un-sell something,” Herron said. “If you’re going to make that big a change [in tax policy], you should do it as a year-end type of deal to give people time to plan.”

Retroactivity will cause a lot of tax pain without adding much to the tax revenue that would be collected from the increase, said Marcus Blanchard, founder of Focal Point Financial Planning.

“A retroactive date on this tax is a sneaky way to try to make up for the massive overspending problem our government has,” Blanchard said. “It won’t move the needle for them. Imagine if your employer decided to retroactively reduce your pay on work you’ve already done.”

The Biden tax hikes, which would generate about $3.6 trillion over a decade, have dominated conversations between advisers and clients over the last few months. A retroactive tax increase doesn’t leave many options for advisers and clients in terms of avoidance strategies. But there are some steps that can reduce the hit.

“There are certain ways we can structure the sale to defer capital gains, which are going to be even more valuable in the year moving forward,” Blanchard said. In addition, “if we can harvest losses, then we want to do that as much as possible.”

In addition to tax-loss harvesting, delaying the recognition of capital gains, gifting or donating them, and timing income are other options for navigating future taxes, said Nate Nieri, owner of Modern Money Management.

If the retroactive capital gains increase is approved, it would be “water under the bridge,” Nieri said. But it also can be an inspiration to find new ways to make a financial plan respond to unexpected developments.

“I’m trying to get creative,” Nieri said. “This stuff is always going to happen. How can we turn this into an opportunity that’s going to benefit [a client]? There’s always an opportunity if you know where to look.”

Bloomberg News contributed to this story.