Biden Tax Proposal: 6 Potential Changes for the Athlete

The latest Biden tax proposal was released – and the usual uproar took place soon after from all sides of the political spectrum.

           Elite financial planning begins and ends with taxes, regardless of the current tax law that is in place. Let’s remove political emotion for the time being and focus on the implications of this tax proposal.

           This article aims to highlight the importance of WHY tax planning matters, and then pull out the changes to the tax code that will have the most significant impact on the athlete. The 6 potential changes are below:

1. Top Federal Tax Bracket Increases to 39.6% from 37%
2. Top Capital Gains Rate Increases to 25%
3. Prohibition of Roth Conversions for Families with Income > $450,000
4. Elimination of Back-Door Roth Conversions
5. Crypto Wash Sale Rules
6. Estate Tax Exclusion Reduced by 50%

Tax Planning is Always Needed

           Is this the first time a tax proposal from the current administration has changed or increased the tax code? Of course not. Below is a chart of the changes in tax rates from 1910 – 2016.

Notice that the top tax rate (blue line) has moved considerably over time, and its peak was 91%. Regardless of the tax code in place – tax planning is always needed for maximizing a family’s wealth. A wise person once told me:

“Investments are a matter of opinion; taxes are a matter of fact.”

           The topics noted below are meant to document strategies a family can implement to have maximum impact to achieve their life priorities. Every dollar saved from a tax perspective provides that greater impact your family deserves. We cannot stress that enough – taxes avoided through appropriate planning provide a greater opportunity for a family to achieve their priorities.

1.     Top Federal Tax Bracket Increases to 39.6% from 37%

Every dollar saved through tax planning strategies; will save an additional 2.6% for the highest income tax earners. Easy take away, but this should highlight the importance of income tax planning.

For example – if an athlete has endorsement income, income from trading cards, or any 1099 income earned, taxes can be reduced by setting up a retirement plan called a solo or Individual 401k . This is a 401k account that is separate from a MLB player’s Vanguard 401k plan, which is administered through the team and has no affiliation with endorsement income.

Through this plan, an athlete can contribute 20% of endorsement income into the Solo 401k, which is capped at $58,000. This contribution is tax deductible, and a max contribution of $58,000 saves the athlete $22,620 in taxes paid, based on the 39.6% tax rate under the new proposal.

2.     25% Top Capital Gain Rate

Currently, the top capital gain tax bracket is 20%, and the Biden tax proposal will raise the top rate to 25% (28.8% when combined with a 3.8% surtax on net investment income). This tax applies to investments (think stocks, bonds, real estate, currency) sold after the family holds the investments for one year or longer. This rate goes into effect for sales of investments after 9/13/2021.

While there is little planning from a sale of investments perspective – there are advanced planning opportunities available still at the disposal of the family.

Tax Loss Harvesting

In March of 2020, the global stock market tumbled, and many families saw their investments go from a positive return to a negative return.

If invested appropriately, families should have sold their investments at a loss in 2020. Losses from investments when sold can be netted against future taxable gains. This limits the family’s capital gain tax impact in the future.

For example, a family we work with had over $1 million dollars of losses recognized during March 2020. About 14 months later, they desired to sell their primary home in Florida, and relocate back to their original hometown in California. Their home in Florida had appreciated in value considerably, and if they sold it, they would have a $1.5 Million gain, of which $1M would be taxed at the capital gain tax rate of 20%.

By executing the losses in March of 2020 – the family was able to net those losses against the gains of their home sale. This created a tax-free transaction – the family avoided $200,000 in taxes paid.

Appreciated Stock Giving

To charitably inclined families, giving long term appreciated stock instead of cash to charitable organizations will be a way to legally avoid the capital gain tax.

For example, a family we work with had an annual goal to give $775,000 away to charitable organizations. The family had a sizable taxable investment account with many mutual funds that held long term capital gains.

By giving $775,000 worth of investments with long term capital gains instead of cash, this family avoided paying the capital gains tax associated with those investments. These investments had almost $200,000 of appreciation, which would equate to a capital gains tax avoided of $40,000.

3.     Prohibition of Roth Conversions for Families of Income > $450,000

This advanced strategy moves tax delayed accounts (401ks, IRAs, 403bs, etc.) to a tax-free account, called a Roth IRA. Roth IRAs are an incredible account for any household to own. To fully understand their impact, we first need to understand the benefits Roth retirement accounts provide:

• Once in the Roth account, investments grow tax free.
• Funds can stay inside the Roth account if you are alive. There are no required minimum distributions at age 72, as with an IRA or 401k.
• Heirs can inherit tax-free assets.

There are income limits on who can contribute to Roth IRAs, and almost all readers of this article will have income north of the Roth IRA limit. Given this, many wealthy families implement a strategy known as a Roth Conversion. This strategy allows the family to do 3 things:

• Control the family’s tax bracket on future income needed.
• Allow for investments to grow tax free.
• Introduce flexibility by avoiding taxable required distributions (not required in Roth accounts).

Currently under the existing tax code, there are no income limits or limits on the number of conversions a family can execute. Under the new proposal, Roth Conversions would be eliminated for families who make greater than $450,000, beginning 01/01/2032. There is a 10-year phase in period, and thus families in the highest tax bracket should consider implementing Roth Conversions now, based on their individual situation.

For example, a family who is 35 and has $250,000 in a tax delayed account (IRA, 401k, 403b) will have $884,000 in that account at age 60 assuming a 5% annual growth rate and no future contributions. However, this is a tax delayed account – so assuming this family in in the top tax bracket of 39%, this family will pay $345,000 in taxes upon distribution. This tax payment is controlled and minimized through Roth Conversions, if implemented appropriately.

4.     Elimination of Back-Door Roth Conversions

Similar to #3 above, this strategy allows high income earning families to take advantage of a Roth IRA. If this proposal is passed, the elimination of this strategy will dramatically impact current family planning. This strategy, simply explained, allows families who have taxable income greater than the Roth IRA contribution limit to get funds into a Roth IRA.

To explain the logistics of a Back-Door Roth Conversion, the family contributes funds to an IRA account and then executes a conversion of those funds to a Roth IRA. The family does NOT include the IRA contribution as a deduction on their tax return, and thus the family enjoys the tax-free investment growth of a Roth IRA. This strategy is executed by most advanced planners.

By eliminating this strategy altogether, it is of paramount importance that every family executes #3 above in the allotted 10-year phase out period – otherwise, they may lose out on the ability to get funds into a tax-free account forever. Further, they should execute a Back Door Roth IRA for calendar year 2021.

5.     Crypto Wash Sale Rules

As discussed with tax-loss harvesting, for losses to be harvested, the family must sell out of their current investment at a loss AND with the cash created from the sale. They must NOT buy a substantially similar asset within 30 days of the loss sale.

Under current tax code, this wash sale rule does not apply to crypto currency transactions. For example, a crypto trader who holds Bitcoin in a loss position may currently sell out of Bitcoin, harvest the loss, and buy Bitcoin right away without having to navigate the wash sale rule explained above to harvest the tax loss. Crypto traders should consider harvesting losses to offset future taxable gains now – especially with the increase in capital gain rates to 25% noted above in #2.

6.     Estate Tax Exclusion Reduced by 50%

It should not be a shock to us that the government taxes our ‘estate’ when we pass away. Said differently, the government taxes our assets before we pass them onto our heirs – with the highest tax rate for the estate tax being 40%.

Currently, for married families, the first $23.4 Million ($11.7 Million for single individuals) of assets are excluded from being taxed upon death. To understand how this $23.4 Million is calculated, think about everything you own – your investments, your home, businesses, executed contracts for income, even the death benefit of your life insurance policies are included within this $23.4 Million.

Advanced estate and tax planning is needed for families who have greater than $23.4 Million of assets to appropriately navigate paying and minimizing the estate tax bill.

For example, we work with a family who has a net worth of about $66 Million. As it stands, if both the husband and wife were to pass away, they would owe an estimated $17 Million in estate taxes due, after including the $23.4 Million exemption.

To plan for this tax payment due, there are many ways in which a family can direct the cash outlay, and mitigate taxes paid. Strategies at their disposal include life insurance held in an irrevocable trust, charitable contributions, or the creation of specific charitable and/or asset transfer trust documents.

Needless to say, this advanced planning would now apply to many more wealthy families. Under Biden’s proposal, the estate tax would now apply to married families with assets over $11.7 Million, and single individuals with assets over $5.85 Million.

Conclusion:

None of these proposals are set in stone, nor is it certain that they will become law. This article’s aim is to highlight the importance of expertise and appropriate tax planning, regardless of current tax law. Our family office aims to do just that – provide expertise to families to maximize the impact their wealth can have on themselves, their families, and those that are important around them. You deserve the best advice – partner with the best to own your wealth and make an impact.

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