A Biden Win Would Transform How the Wealthy Invest Their Money | Bloomberg

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By Ben Steverman and Laura Davison | October 16, 2020

A Democratic administration could scrap techniques used for decades to shrink taxes on their investment gains.

Wealthy investors are getting ready to overhaul their portfolios and revamp long-standing strategies if former U.S. Vice President Joe Biden and Democrats win big in November.

While Biden has rejected the wealth tax pushed by Democratic primary rivals Elizabeth Warren and Bernie Sanders, his proposals could seriously disrupt the many ways that rich Americans minimize — or altogether avoid — taxes on their investment gains.

“The fact is that we ought to start rewarding work, not just wealth,” Biden said in a February debate. He added that it’s “wrong” that billionaires pay lower rates on capital gains than employees do on their salaries.

While investors are divided on what a Biden win would mean for the stock market, what really worries advisers to the wealthy is how Biden and a Democratic Congress could force them to scrap techniques used for decades to shrink tax bills.

“These proposals will absolutely change how some money managers manage portfolios,” said Alison Hutchinson, managing director at Brown Brothers Harriman.

There are two main areas of concern for wealthy investors:

Stepped-Up Basis

Especially painful would be the elimination of “stepped-up basis,” an obscure rule that Biden has decried for years, which wipes away taxable gains when property is inherited. Used cleverly, stepped-up basis can allow rich families to never pay taxes on investment windfalls.

If Biden wins with Democratic majorities in Congress, “you’re going to have a lot of people scrambling,” said Marcum partner Edward Reitmeyer. “The hardest thing for people to get their arms around is this possibility of not having a step-up in basis — that is such a drastic change in history. It’s really kind of a game changer.”

Rate on Capital Gains

Investors may also be in for a much-higher rate on capital gains. When wealthy Americans sell stocks now, they pay a top rate of 23.8%, including 20% on capital gains and a 3.8% levy created by the 2010 Affordable Care Act — much less than the 37% top rate on ordinary income. Biden would end this lower rate on investors, while also boosting the top rate to 39.6%.

“Everyone is assuming higher taxes, but the capital-gains issue is a very big focus for some of our clients,” said Craig Smith, president of Tiedemann Advisors. “I’ve never seen so many conversations around this at one time.”

The prospect of much higher taxes — and fewer ways to avoid them — is prompting many rich Americans to radically reconsider their investment portfolios and think of strategies to trim their exposure:

Offload Their Shares

By selling appreciated stock before the end of the year, for example, they may avoid a potential tax hike in 2021.

“We’re not selling anything today,” said Craig Richards, director of tax services at Fiduciary Trust Company International. But he and advisers are talking with clients about sales to make by the end of 2020 if Democrats win big in November. “We want to have those conversations and identify where there’s opportunities to sell, paying a rate that could be half of the rate next year,” he said.

Wait Until Next Year

Other investors may actually delay selling investments if Biden wins big. Stocks that have lost value are typically sold at the end of the year, a technique known as tax-loss harvesting that lets investors use those losses to offset other income and lower their tax bills. “Those losses could be worth a lot more next year,” said Stephen Baxley, director of tax and financial planning at Bessemer Trust.

Even if Biden and Democrats win handily, it’s not clear that taxes would rise right away. Biden has said during his campaign he would repeal Trump’s tax cuts on “Day One” of his administration, but that may be put off as White House and Congress address the ongoing coronavirus pandemic. Democrats’ first legislative task would likely be another round of deficit-financed economic stimulus. That would mean that any tax increases wouldn’t come up until the end of Biden’s first year in office at the earliest.

For decades, the wealthy have tried not to sell investments that would trigger large capital gains tax bills. Hold on long enough, the theory went, and the stepped-up basis rule means those gains won’t ever be taxed.

Rich Americans often borrowed against these holdings to raise cash — a transaction that isn’t taxable — and used sophisticated strategies and financial instruments to hedge the risk that this lack of diversification poses to their portfolios.

Years of relying on such techniques could make Biden’s proposals much more expensive for many wealthy families.

It could be particularly difficult for rich investors who have borrowed against their fortunes. “The problem” with this debt, Reitmeyer said, is “then you might not have the cash to pay the tax” when assets are sold.

On the other hand, changing stepped-up basis rules might also simplify the financial lives of wealthy people whose fortunes are concentrated in just a few stocks — generally the businesses that made their families rich in the first place.

Ending stepped-up basis “would open up a lot of opportunities to diversify portfolios,” BBH’s Hutchinson said. The change could also boost charitable giving, she said, assuming rules remained in place that allow the Americans to avoid capital gains taxes by giving appreciated assets to philanthropic organizations.

Taxes aren’t the only reason that the wealthy avoid selling investments with big gains. Many well-off families have an emotional attachment to the companies that made them rich, said Tiedemann’s Smith. The threat of higher taxes is pushing some investors to re-consider these ties.

“So many of our clients in that situation are asking us to analyze: ‘Should I be realizing gains before the end of the year?’” Smith said. “We’re talking about large-scale changes in portfolios.”

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