Taxes? Should you be Worried?

By: James C. Denton, CFP®, Managing Partner

June 30, 2021

This letter is going to be a little different than my normal quarterly newsletter. I will be both more forward looking, and also less investment-performance oriented than usual. We usually discuss what has happened, largely avoid anything more than the most tempered predictions of future performance, and tell you to “stay the course”. The market seems to be fairly stable presently, and while volatility is always a reasonable expectation, there’s no reason to expect any imminent actionable activity. Sticking to your plan is usually the correct strategy, that’s why you have a plan after all, and there’s not much point in dwelling on that right now.

Most of your questions recently, though, have been about taxes; most commonly, “are my taxes going up”. The answer to this question is almost certainly “Yes”, but before you panic (or shout down my phone line that I just last week told you otherwise) let me give you a little more context and detail.

Usually when someone asks this question, they have income taxes on their mind, so let’s address that one first.

It is the closest thing to a certainty as you are likely to see in this world that income taxes are going up soon, if for no other reason than that, (1) for most of us, rates presently are the lowest they have been in our lifetime, and (2) the law that created that pleasant state of affairs expires in 2025. So barring a return to power of Republicans in the congress, as well as the election of a Republican president, it’s reasonable to expect that in 2026, the rates will at least return to where they were in 2017 and earlier. I personally think it unlikely that the Republicans will make that sweeping a recovery in such a short time frame, so I’m expecting a tax increase for just about all of us. Get used to the idea.

A bigger problem exists, however. IMHO, spending versus revenues has been out of control for most of my lifetime, but we are taking this irresponsibility to a whole new level. We have spent a boatload – several super-container ships actually – of cash over the last couple of years in pandemic relief and economic stimulus, and we are not done.

In addition to this arguably reasonable response to abnormal conditions, however, there are currently initiatives in the congress for upwards of $8T of expenditures and all of this $8T is marginal spending … over and above normal budgetary expenditures like social security, defense, Medicare, congressional salaries, healthcare and pensions, and keeping the lights on in the White House and the Statue of Liberty. The policy wonks call it “entitlements” and fixed costs. Can’t be cut.

Worse, all of this spending, what has been spent, and what is being contemplated, is being done on borrowed money which means a huge increase in debt service … i.e., interest on all that borrowing. If interest rates go up, and our additional borrowing almost guarantees that they will, … well, you don’t have to have a PhD in Economics to understand the problem. So taxes will have to go up at some point beyond any currently expected “normal” increase. Again, get used to the idea.

Your questions, though, are probably a result of the president talking about near term tax increases. You can take heart on this one. So far, he is promising not to raise rates for anyone making less than $400K per year, and the most heinous changes are reserved for those over $1mm. Not too many of the latter are paying much attention to what I have to say, and even for those of you in the $400K crowd, it’s only a small increase (2% for marginal dollars over $400K) so there is nothing here for most of us to get too excited about right now, and it is a reasonable question as to whether he’s going to be able to get even these minor changes through the dysfunctional senate.

So insofar as income taxes are concerned, I would tell the vast majority of you to take comfort. There shouldn’t be much in the way of near-term danger, and longer term, a return to pre-2018 rates is probably to be expected, we’ve been there, and you tolerated it. I wouldn’t lose too much sleep dreading it.

But what about Estate Taxes? This a potentially greater danger out there, and it may impact a lot of you for whom it is the farthest thing from your mind. There’s an adage with which most of us are familiar … “Those who fail to learn from history are doomed to repeat it”. So let’s talk a little history here.

The estate tax has a fairly long and enduring history. One source says it was first enacted in the US in 1797[1]. Another says forms of an estate tax can be found as early as 700 BC[2]. It has been around a while. But it has a tendency to come and go, and was actually eliminated multiple times in the past century, (an important factoid to which we shall return) most recently for the year 2010. Anyone, regardless of wealth who died in the US in the year 2010 was able to pass their entire estate to their family without a single dollar in federal estate taxes. (State estate and inheritance taxes are not the subject for this article but should be kept in mind when you are considering estate planning).

This 2010 experience was short lived, however, and in 2011 the federal levy was resurrected. Currently it is somewhat benign when compared to what it has been. When I first got my start in the financial planning business for example, the federal tax kicked in for any estate exceeding $600,000, and rates quickly escalated to the extent that, when federal and state income, estate and inheritance taxes were combined some estates were subject to total levies that could reach 80 to 85%.

Substantial exemptions currently exist which, with proper planning and execution can reach $23mm. So not too many of us are expecting to leave that much behind, and among those who do, not too troubled about our kids paying taxes on an inheritance over $23mm, right? A very reasonable thought process, but perhaps not well considered.

Let’s go back to the previous factoid which we temporarily set aside, for a very basic question … How can anything that is “eliminated” multiple times ever be considered well and truly eliminated? If something is “temporarily” eliminated, is it really eliminated or is it just suspended? Think about this. How many tax cuts – or increases for that matter – have you ever known to be “permanent”? We hear the term all the time but the next year, what was said to be “permanent” turns out not to be.

I’m not trying to be amusing here, while this sounds like a bunch of circular nonsense, it’s really a very important concept and here’s the reason.

If you build your financial and, in the current discussion, estate planning, around an assumption that current conditions are permanent and dependable, and then they turn out not to be, the impact can be devastating. And you can’t, for a variety of very good reasons beyond the scope of this article, count on being able to adjust your plans if and when circumstances or the law change.

Finally, what’s the outlook for let’s call it “staying power” of the current rules? Most of the Democratic caucus, and a few Republicans as well, are at least open to discussion of significant increases in estate taxes. Senator Bernie Sanders has a proposal to reduce the exemption to $3.5mm, with rates starting at 45% and topping out at 77% for estates above $10mm.

Bernie Sanders is a gadfly, you say. Not a chance. Well, Bernie Sanders is the chairman of the Senate Budget Committee. He’s not an impotent old man. I agree, he’s not likely to get all he wants, but he has a critical mass of the Democrats in Congress, and he has the president’s attention on this subject so I believe the chances are good that something is going to happen.
More of you than you probably realize have already achieved Bernie’s $3.5mm baseline, and have a very good chance of leaving a taxable estate behind that exceeds his $10mm “super-rich” threshold.

Now all of these numbers are nominal and I’ve probably rambled a bit too much as usual, but here’s the take away.

First, as I hope I have made the case, far more of us are at risk of (or perhaps privileged enough to be threatened by) this tax than many of us realize. And it is threatening enough that we should be taking it far more seriously than we do.
There are very reasonable, and very affordable measures that can be taken to greatly reduce the impact that virtually every one of you should be undertaking.
And there are more sophisticated strategies for those more at risk.

But the main point is this … Don’t count on the idea that, because the estate tax exemption is whatever it happens to be at a given point in time, and you don’t expect to ever fall outside of today’s protective envelope, that you can put your head down on your pillow at night and not worry about it unless and until things change. Because (1) you might be more at risk than you realize even without change, and (2) change things will, and probably for the worse.

[1] A Brief History of Taxes in the U.S. (investopedia.com)

[2] Estate Taxes: An Historical Perspective | The Heritage Foundation

The opinions expressed in this article are those of the author and may not reflect those of LPL Financial. This material is for informational purposes only and should not be considered as investment, tax, or legal advice for any individual. You should consult with your personal advisors before making any decisions from this material. LPL does not give tax or legal advice.

Past performance does not guarantee future results. The economic forecasts set forth may not develop as predicted and there can be no guarantee that strategies promoted will be successful.