There's been no shortage of handwringing about the prospect of tax increases over the course of the past year. Worried about potential tax changes, some business owners pushed ahead with sales or other liquidity events, while investors raced to book gains in 2021.
However, as 2022 progresses, the tax legislation spurring those actions faces a highly uncertain future. And for business owners and investors who were facing increases, the most recent drafts of the Build Back Better Act suggest several future planning options to mitigate the pain.
First, Put Matters into Perspective
Let's start big picture. Tax considerations are important, but they are often secondary to business and investment planning. Focusing on business operations and growth can drive valuation increases that more than pay for future tax hikes given the right investment timeline. This same logic applies to investment assets, as investors weigh expected value appreciation against the potential for tax increases. Attempting to complete sales before tax changes take effect could result in lower tax rates, but might also come at an economic cost.
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Fortunately, financial projections and tax modeling can bring clarity to an uncertain future.
The Build Back Better Plan Has Evolved
It's worth noting that the most recent legislative proposals are a significant retreat from the earlier push to raise capital gains taxes for the highest earners to a combined 43.4%. Instead, the version of the Build Back Better Act most recently under consideration in Congress would add a surtax to push up rates on all income — not just capital gains — for taxpayers only over specified income thresholds.
That surtax would be:
- 5% on income over $10 million.
- An additional 3% on income north of $25 million.
- For trusts and estates, significantly lower thresholds of $200,000 (for a 5% surtax) and $500,000 (for an additional 3% surtax) would apply.
Those income thresholds would narrow the scope of tax increases as compared to an actual increase in capital gain rates. They also serve as the key to tax-planning opportunities.
Let's also remember that the proposed tax increase on capital gains through the surtax is just that — a proposal, subject to congressional negotiations. Last fall it appeared that there was momentum for tax legislation on Capitol Hill, as the House passed a version of the BBBA and the Senate began its deliberations. However, that progress stalled, and the likelihood of significant tax increases is diminishing.
Opportunities for Business Owners
That said, tax increases do matter, and if you're already planning to transition out of your business or investments, tax planning could minimize your liability.
One tactic business owners might consider is an installment sale. Stretching out the payment of purchase price over an agreed-upon number of years could help sellers keep their annual income recognition from the sale below the threshold that would trigger the surtax.
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Installment sales aren't for everyone. They have the notable drawback of sellers assuming economic risk for the unpaid portion of promissory notes until the final payments are received. An interest charge may also apply to the deferred tax liability, depending on the amount of deferred gain.
A similar but potentially less risky option would be to sell businesses in phases, with each sale of a stake treated as a stand-alone liquidity event.
Sellers might also explore selling stock under the qualified small business stock gain exclusion. Those rules uniquely allow for the permanent exclusion of taxable gain, though the eligibility requirements are strict. The Build Back Better Act included proposals to reduce the maximum benefit of the gain exclusion. However, a gain exclusion of any type is always beneficial and would provide amplified benefits to taxpayers above the surcharge thresholds.
The potential for tax changes could also prompt business owners to revisit their plans around gifting or succession, both potential avenues to divest from the business in a tax-efficient manner. Tax changes involving gifting and estate planning were removed from the Build Back Better Act during the legislative process, but business owners should continue to watch that area closely.
The Bottom Line
There's little we can be certain about with upcoming tax changes. But it's a safe bet that taxes won't go down anytime soon, and business owners are right to pay attention. Yet, setting out to eschew growth to escape a future of higher taxes may be counterproductive. It’s often better to focus on making your business as successful as possible, and then when it comes time to sell, figure out the most tax-advantageous way to do it.
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Disclaimer
This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.
FAQs
The Bottom Line. There's little we can be certain about with upcoming tax changes. But it's a safe bet that taxes won't go down anytime soon, and business owners are right to pay attention. Yet, setting out to eschew growth to escape a future of higher taxes may be counterproductive.
Is increasing tax good or bad? ›
How do taxes affect the economy in the long run? Primarily through the supply side. High marginal tax rates can discourage work, saving, investment, and innovation, while specific tax preferences can affect the allocation of economic resources. But tax cuts can also slow long-run economic growth by increasing deficits.
What will 2026 tax rate be? ›
Under the TCJA, the tax rates are 10%, 12%, 22%, 24%, 32%, 35%, and 37%. On January 1, 2026, the rates return to their pre-TCJA amounts of 10%, 15%, 25%, 28%, 33%, 35%, and 39.6%. The income brackets to which those rates are to apply will also be different and are adjusted for inflation each year.
What happens if taxes increase? ›
An increase in income taxes reduces disposable personal income and thus reduces consumption (but by less than the change in disposable personal income). That shifts the aggregate demand curve leftward by an amount equal to the initial change in consumption that the change in income taxes produces times the multiplier.
Will taxes be higher in the future? ›
Planning for an uncertain future
Given the current state of government debt and looming solvency issues with major entitlement programs, it's reasonable to conclude that revenue needs will lead to tax increases. Whether these will be limited to higher-income taxpayers remains to be seen.
Why shouldn't we increase taxes? ›
Higher corporate taxes would also reduce the profitability of new investments, further dampening the incentive to increase production. It's true that less investment means less business spending, but because less investment also leads to less supply, the net effect could be to increase inflation pressures.”
Does raising taxes stop inflation? ›
Raising taxes on the wealthiest Americans pushes inflation in the right direction, but it has a relatively small effect. This is because the wealthiest Americans have a lower marginal propensity to consume their income: when taxes go up on billionaires, they reduce their consumption, but not by that much.
What will 2025 tax brackets be? ›
Key Tax Provisions That Are Expiring After 2025
- Tax brackets: The individual income tax rates of 10%, 12%, 22%, 24%, 32%, 35% and 37% will return to 10%, 15%, 25%, 28%, 33%, 35% and 39.6%, with different income-level break points than now.
- Bigger standard deductions: The 2017 law more than doubled these breaks.
The $10,000 limitation on state and local taxes (state income taxes, real estate taxes, personal property taxes, etc.) will be removed. This limitation can be a significant benefit to taxpayers in high income tax states, such as California and New York.
Will federal taxes increase in 2025? ›
On a gross basis, we estimate Biden's FY 2025 budget would increase taxes by about $4.4 trillion over that period. After taking various credits into account, the increase would be about $3.4 trillion.
If you make $60,000 a year living in the region of California, USA, you will be taxed $13,653. That means that your net pay will be $46,347 per year, or $3,862 per month.
Why is my refund so low in 2024? ›
If a taxpayer refund isn't what is expected, it may be due to changes made by the IRS. These changes could include corrections to the Child Tax Credit or EITC amounts or an offset from all or part of the refund amount to pay past-due tax or debts. More information about reduced refunds is available on IRS.gov.
Why are my federal taxes so high? ›
Different income tax brackets apply depending on how much money you make. Generally speaking, a higher percentage is typically taken out of your paycheck if you earn a higher level of income.
What is the new tax law in 2024? ›
Key provisions in the Tax Relief for American Families and Workers Act of 2024. The bill provides for increases in the child tax credit, delays the requirement to deduct research and experimentation expenditures over a five-year period, extends 100% bonus depreciation through 2025, and increases the Code Sec.
Are income taxes going up? ›
The IRS has released higher federal tax brackets for 2024 to adjust for inflation. The standard deduction is increasing to $29,200 for married couples filing together and $14,600 for single taxpayers.
Why are my taxes increasing? ›
Both federal income tax brackets and the standard deduction were raised for 2024. The higher amounts will apply to your 2024 taxes, which you'll file in 2025. It's normal for the IRS to make tax code changes each year to account for inflation.
What are the pros to increasing taxes? ›
Economic Stability: They contribute to economic resilience during downturns. Reduced Income Inequality: High payroll taxes can help in leveling income disparities. Long-Term Benefits for Employees: Ensures secure retirement and healthcare benefits.
Why is raising income tax good? ›
Moving toward more robust taxation of Californians with higher income and wealth would also generate revenues that can be spent equitably to help more low-income households and Californians of color live and thrive, and expand opportunities to build wealth for themselves, their children, and their communities.
Are high taxes good? ›
History shows that higher taxes are compatible with economic growth and job creation: job creation and GDP growth were significantly stronger following the Clinton tax increases than following the Bush tax cuts.
Why increasing sales tax is good? ›
Sales taxes support public services that bolster a sense of community such as libraries and parks, public services that make us feel safe such as police and fire departments, and public services that make us healthier such as hospitals and mental health facilities.
