I try to stay away from the television and, in particular, the news. Too much sensationalism and a tendency to report only on bad news.
However, there is some coverage that I think doctors should pay attention to.
New Tax Laws
On April 22. 2021, President Biden proposed his American Families Plan, which included a number of significant tax changes. While this is not the kind of literature that is relaxing or fun to read, I suggest you pay attention.
As is common for politicians, the rallying cry is that “only the wealthiest will be affected.” That fits right in with, “The check’s in the mail,” or “I’m from the government – I’m here to help.” The truth is usually something different.
When you hear those words, you can be sure that hard-working physicians will feel the sting.
Biden’s proposals are just that. They have been laid out as the direction in which he would like to proceed, but they still must be voted on and passed by congress. You can be sure there will be hot debate.
While all the changes will likely not be enacted, those I’ve spoken to believe many will pass and become law.
If they are passed, this will be the highest tax burden seen by Americans in the last century. The estate tax burden could be as high as 61% for your heirs – nearly twice what it is now.
Here is a synopsis of the proposed changes:
- Increase the top individual tax rate from 37% to 39.6%
- Expansion of the Net Investment Income Tax (NIIT), which was the extra 3.8% originally added to pay for the Affordable Care Act
- Taxpayers with incomes over $1 million individually or $2.5 million as a couple would see long-term capital gains tax increased from 23.8% to as high as 43.4%
- Elimination of the Section 1031 like-kind exchange for gains above $500,000
- Reduction of the estate tax exemption from $11.7 million per person to somewhere between $1 million and $5.3 million.
- Elimination of the step-up in basis at time of death
- Unrealized capital gains over $1 million will be triggered at death and taxed whether property is sold or not
- 40% estate tax on anything above the legislated exemption
How does it Affect Doctors?
You might look at these numbers and feel that your income won’t place you in the line of fire. But the last time I looked; many physicians are still bringing home a sizable paycheck. These changes could affect many of you.
The changes in the estate tax law could affect even more.
For instance, if your parents were to pass away, any real property in the estate would be taxed immediately at the proposed ordinary income tax rate of 43.4%. This would occur whether you sold the property or not.
For instance, your folks were somewhat entrepreneurial, and they bought a moderate-sized real estate property thirty years ago for $250,000. That property is now appraised at $1.25 million.
At the time of their passing, you would be responsible for the tax on a million dollars of unrealized gain. At the proposed rate, you would pay $438,000 in tax, leaving you with $562,000, plus the original basis of $250,000, for a total of $812,000.
But it’s not over. Then, according to Biden’s proposal, you will pay 40% estate tax on the remaining $812,000, equaling $324,800. This would leave you a total of $488,000 out of the original $1.25 million.
That is a tax rate of 61% and it is due whether you sell the property or not.
This is just an example and doesn’t take into account the estate tax exemption, which currently is at $11.7 million per person, and $23.4 million per couple. So, today, you would not be taxed on the inheritance of this property.
However, that exemption is proposed to be lowered to somewhere between $1 million and $5.3 million.
This is only a simple example, and I am fully aware that the numbers might be different in the future. But if there is to be a change, what can we do about it?
What Can You Do?
I am not a CPA or an attorney, so I don’t give advice. However, here is what I’ve been told by those that live in this arena.
Do your planning now – before 12/31/21.
While there is no guarantee what will be passed, if you wait until the proposals are law, you might not have time to make the changes. You might not even be able to get an estate attorney to answer their phone. They will be very busy through the end of this year!
If you have assets in your personal name, and you wish to transfer them into a limited liability entity, you might explore making that transfer before the end of the year.
If you have real estate that you might want to exchange for other property and defer the tax, it might be best to get that done this year.
If you don’t have an estate plan to take care of your kids when you’re gone, you might set one up before the year is out. Having just gone through such an exercise, I can tell you that your children or heirs will appreciate detailed and thoughtful plans!
If your parents don’t have an updated estate plan, it might be worth having that discussion.
If you do have an estate plan, it could be helpful to have it reviewed and make changes that will be beneficial to you and your children if these laws are passed. There are ways to pass a large portion of your estate to your heirs with minimal tax consequences and still retain control of the assets. Speak to your attorney.
It’s never fun to think about this stuff and it is usually confusing. You certainly don’t want to run scared and it’s not the end of the world to pay some taxes, but you don’t want to get an unpleasant surprise.
Tax savings produce an immediate return on your investment. Today, many physicians are branching out into real estate, business, and other side gigs. If those plans flourish, you will want to legally keep as much for yourself and pass on as much as possible to your children, or to the charity of your choice.
You might find that your estate is well-positioned for you and your heirs, but at the least, you will have some peace of mind going forward.
A little planning goes a long way!