Future Returns: A Wealth Management Take on Biden’s ‘Billionaire Tax’

Americans are curiously watching the Biden administration’s billionaire minimum income tax to see if it…

Americans are curiously watching the Biden administration’s billionaire minimum income tax to see if it can solve the problems it promises to—from tax equity, to overcoming the objections its predecessors faced.

The initiative, proposed for the 2023 federal budget, would apply to households worth over US$100 million and will tax at least 20% of full income, including unrealized appreciation. (Households already paying that amount won’t face additional tax under the proposal.)

“It obviously applies to a lot more than billionaires,” says
Pam Lucina,
chief fiduciary officer at Northern Trust Wealth Management in Chicago. “And that’s certainly different than other wealth taxes that have recently been proposed.” 

Democrats in the U.S. Senate explored a similar billionaire tax last October to help pay for social spending plans. It didn’t gain wide support.

Central to this current proposal is taxing unrealized income or investment growth, which the White House characterizes as a way to make taxation more equitable. 

“If tax-free unrealized income allows a wealthy household to pay less than 20% on their full income, they will owe a top-up payment to meet the 20% minimum,” The White House said in a news release. 

Top-up payments can be spread over several years to “smooth year-to-year variation in investment income.” The White House suggests that within 10 years this new tax will cut the deficit by about US$360 billion, with over half this revenue coming from households worth more than US$1 billion.

Though federal wealth tax reform is rare in the U.S. the proposed change is poised to be the most significant since the Reagan era in the 1980s—several countries, including Spain and Switzerland, collect net wealth taxes on high-net-worth households.

“Wealth taxes have been proposed and enacted in states as well, so Biden’s move isn’t completely unprecedented,” Lucina says.

The proposal attempts to minimize some arguments and criticisms made against wealth taxes in the past, she says. For example, to counteract the difficulty of getting valuations every year on illiquid assets, this proposal offers a formula to work from. Even so, critics including West Virginia Senator
Joe Manchin
still argue against taxing unrealized gains as proposed.

“Another issue that people have raised in the past is that a tax on wealth is unconstitutional and this attempts to say it’s a tax on unrealized gains,” Lucina adds. “Whether that’s a nuance that has constitutionality—that’s anyone’s guess.” 

In an interview with Penta, Lucina spoke about how households facing this potential new tax should consider approaching it.

Plan, Don’t Panic

While some investors may feel the instinct to start making changes to their estate plans following the announcement of the tax, Lucina thinks they need to ignore that urge. [ Instead it’s time to step back and focus on planning.

“Keeping awareness that this exists is good, prudent planning,” she says. “But reading too much into any particular provision would be difficult at this point.” If a billionaire tax plan gets enacted it likely will look different than Biden’s proposal. Instead, the proposal is more indicative of a general direction that will be followed.

In a broader sense, the fact a billionaire tax proposal has come this far may be a signal to start thinking about such taxes differently. With an increasing number of Americans supporting such taxes in recent years, even if this particular proposal doesn’t go quite as far as expected, it may open up future opportunities to go in that direction. Or even further.

“It’s a slippery slope because it could start to apply to more and more people,” Lucina says.

Use Goals as Guidance

Anticipating future tax regulations is difficult, if not impossible. That’s why investors should center their wealth management plans around their financial goals, instead of building them around tax law predictions.

Lucina says goals to keep in mind include an investor’s cash flow needs, how they want to benefit family members, and whether or not they want to benefit charities. “Those things should be your guide, and then you want to try to do it as tax-efficiently as possible.”

It’s important not to make decisions like creating entities or making changes to existing structures based on tax law predictions. “In 2012, people rushed to create irrevocable trusts based on perceived changes in the tax law, but those changes never came to fruition,” she says. Instead, for maximum flexibility investors should consider different strategies in their portfolio that incorporate ways to exit, if doing so is tax-advantageous.

Lucina also notes taxes aren’t always permanent either. “Taxes are going to come and go with administrations,” she says. For instance, OECD member countries collecting net wealth taxes has varied from eight in 1965, to a height of 12 in 1996, to only five in 2020.

Flexibility in Your Trust Entities

With a new tax looming, a natural opportunity arises to revisit how investors currently plan trusts. When considering new trust strategies, flexible is the word to keep in mind.

Though similar billionaire tax proposals by Democratic Senators
Bernie Sanders
Elizabeth Warren
specifically included trusts as a tax base, Lucina says that based on how Biden’s proposal is written it’s uncertain whether or not it will apply to trusts.

Lucina says trusts should be drafted to allow trustees to make tax-efficient decisions, considering estate, GST (generation skipping tax), income, and now wealth taxes.

If aligned with family goals, Lucina says some types of flexibility investors might like to have include offering trustees maximum discretion to distribute to beneficiaries who may not be subject to this tax and allowing the trust creator to substitute trust assets for equivalent value. Investors may also include a “trust protector.” (Someone who can make changes to or amend the trust in the future, so it aligns with tax-efficient goals.)

“Even with existing plans, there may be options to reform the trust, decant to a new trust, or otherwise modernize the provisions,” Lucina adds. “Do not rule out the chance to make changes.”