America’s Rich and the Coronavirus: Lessons from the past on how to act today

Mar 11, 2020

Sometimes Being a Contrarian is the Safest Plan

With the spread of covid-19 markets are in turmoil and countries in shut-down.  America’s wealthy may well be wondering how the Coronavirus will impact their pockets alongside their health. This article examines how the outbreak may in fact offer an opportunity for high net worth Americans to take action to preserve their future wealth.

“History doesn’t repeat itself but it often rhymes.”

Mark Twain

It’s been three decades since I graduated from law school and began my professional career. Over that time I have identified a few recurring themes which confirm Mark Twain’s famous observation.

America's rich and the coronavirus: impact on markets

The global spread of the coronavirus has had a devastating impact on the markets

America’s Rich and the Coronovirus: Lessons from the 2008 Financial Crisis

The market turmoil of the past few weeks brings back stark memories of the fall of 2008. The level and breadth of economic upheaval that were triggered by the housing bubble is happening again. This time the weak sectors were exposed by the Coronavirus leading to an oil war between Saudi Arabia and Russia, stock market bubbles bursting globally, and calls for Democratic Party “Tax the Rich” policies. What specifically is to blame is secondary to the reality that markets are experiencing a steep downturn across the board.

Just as in 2008, most everyone is seeing an overall decline in market values… but not everyone is responding the same way. Twelve years ago members of the herd fled and sold the holdings at a loss. They only returned once the market had rebounded. Subsequently It took them many years to recover their pre-crash conditions. Other investors believed that the appreciated investments in their portfolio were fundamentally strong. They saw this as an opportunity to realize capital gains at a lower valuation. They believed that the market would ultimately recognize the true value of their holdings and would return to pre-crisis levels….and they were right!

Why should this downturn be of interest to high net worth Americans? How might it help to preserve their wealth and freedom of choice?

Prior to the Coronavirus meltdown, many HNW Americans were already considering two complementary strategies to help them better protect the future potential of significantly increased taxation. These strategies are “Playing the Game Better” and the backstop of “Leaving the Game.” I speak from experience as I was working with their trusted advisors to put these strategies in place. My message to those who have not already undertaken this work is that now is the time to act! The current market uncertainty is a wonderful opportunity to move forward and be in a position to significantly reduce their future tax burden.

Prior to the current market meltdown, what were some Wealthy Americans concerned about?

Democratic POTUS candidates have changed their rhetoric from “Getting money to spend on good things” to “Taking money from bad people”. Since this shift I have seen my HNW American clients moving from concern to action. They understand that, should the Democrats sweep in November,  there will be (at a minimum) a doubling of capital gains rates. If the progressive wing were to influence the party platform, there is also the distinct possibility of a Wealth Tax, increased estate taxes, and a major jump in ordinary income rates.

Some may agree with some of these proposals. However, their fear is that populism may drive legislation to a level that they consider excessive.

How should Wealthy Americans react to the possibility of a Future Democratic Regime?

As a Wealthy American you should prepare in the same way that they would with the threat of a wildfire. Namely use fire prevention techniques, along with purchasing insurance and developing a fire escape plan. You do this not because there is a more than a 50% PROBABILITY of a fire (or Democratic sweep). Rather, you act because it is a POSSIBILITY.  If it were to occur when you do not have these tools in place, the impact would be devastating. There are numerous uncertainties around the upcoming election: party allegiance, voter preference or overly optimistic predictions. These factors should not blind wealthy Americans to the logic that they should also plan for the worst possible outcome.

And the Coronovirus meltdown gives them a great reason to do so now.

America's rich and the coronavirus: what action to take

The efficacy of a face mask may be in doubt, but acting now to preserve future wealth is definitely advisable!

What Practical Steps Should Wealthy Americans take right now?

As noted above, Wealthy Americans should immediately look into developing BOTH

  1. fire prevention strategy (i.e. “Playing the Game Better”) and
  2. an exit strategy (i.e. “Leaving the Game”) should prevention prove inadequate.

What are some “Play the Game Better” strategies?

One technique used successfully in the 2008 crisis is to take advantage of a temporary suppression in value and realize existing capital gains. This action will result in a lower capital gains bill AND a step-up in valuation. This may be especially useful for private companies or pre-IPO founders’ shares. With discounting opportunities (e.g. lack of marketability discount, blockage discount i.e., large share block), minority interest discount (including non-voting), restricted securities (i.e. can’t be sold w/o registration or subject to shareholders agreement) and so forth), a defendable valuation can be quite favourable…. especially in a post-WeWork disaster era.

With a step-up basis, if there is a future increase in capital gains rates, the increased rate will only apply against a much smaller future capital gain.

America’s Rich and the Coronavirus: how can triggering capital gains in the short-term help with an Exit strategy?

Whilst ‘Playing the Game Better’ it is also important to prepare a ‘Leave the Game’ strategy as a backstop. This way wealthy Americans are in a position to consider having one family member trigger a complete departure from the US tax system and thereby protect the family wealth.

With an increased cost basis, any “Exit Tax” that may be applicable would be greatly reduced. Only the capital appreciation from the time of sale to renunciation would be subject to the Exit Tax. This benefit is even more significant if the promised Biden doubling of capital gains rates or the imposition of a Sanders/Warren 40% Exit penalty is put into place.

To learn more about developing a Leave the Game strategy, interested individuals should read this article and listen to this recent podcast. They should then contact their financial advisors and our firm to discuss how we can all work together to turn fear of the present into an advantage for the future.