Could the recent election impact your year-end tax planning?
The observations below are based largely on information released during the Biden campaign and may not represent what will actually occur should Biden become president. These observations do not cover all of Biden’s tax related proposals, but are instead ones that can have an immediate impact on year end planning for 2020.
Adjusting TCJA
Biden’s proposed tax plans as announced during the election campaign include his proposed response to President Trump’s most significant legislation during his first term, the Tax Cuts and Jobs Act of 2017 (TCJA). TCJA largely lowered tax rates and increased deductions for both corporate and pass-through businesses. TCJA also lowered the tax rates for individuals and estates and trusts and made many other changes to the tax law.
Biden’s position is that TCJA helped large corporations and wealthy individuals pay less tax. His plans include raising the top tax rates and broadening the tax base for high-net worth individuals and corporations. To this end Biden has proposed raising the corporate tax rate from TCJA’s rate of 21% to 28%. He would also double the tax rate on foreign source income of U.S. based multinational corporations (GILTI tax) from 10.5% to 21%. For pass-through entities, Biden proposes to phase out the Section 199A small business deduction for those individuals with income exceeding $400,000.
Also for individuals, Biden proposes reinstating the 39.6% tax rate, limiting itemized deductions to the 28% tax rate and restoring the phase down of itemized deductions known as the Pease limitation. With respect to capital gains, individuals with income greater than $1 million would not be eligible for the special long-term capital gain rates, but would pay tax on gains and qualified dividends at their generally higher ordinary income rates.
Biden approves of the Opportunity Zone program in TCJA and proses to improve its transparency and effectiveness to benefit the communities in these zones. Taxpayers should consider this option to defer gains realized in 2020 by making smart investments in qualified opportunity zone funds and businesses. Biden indicated he would continue the new markets tax credit program and expand the work opportunity tax credit to include additional targeted groups of under employed workers.
Payroll Taxes
Employers and employees currently split the 12.4% Old Age Survivor and Disability Income tax (Social Security tax) each paying 6.2% on the first $137,700 earned in 2020. Biden proposes implementing a second tier for this tax when wages exceed $400,000. The 6.2% tax would again apply for employers and employees to each dollar of compensation beyond $400,000 with no limit. This additional tax is intended to fund the anticipated shortfall in Social Security.
Estate and Gift Taxes
Biden has indicated a preference for reducing the life time exemption amount to $5 million or less and maintaining the current estate tax rate of 40% or increasing to 45%. He has also expressed interest in repealing the basis step up for appreciated assets held by a decedent at date of death. A similar proposal was circulated during the Obama presidency.
Working with Congress
High school civics class reminds us that Congress, Representatives and Senators, write and approve tax legislation not the President. Both legislative bodies of Congress and the Whitehouse must come to agreement for any new tax legislation to become law. With political party control divided between the House of Representatives and the Senate, it is likely that any final tax legislation will not look exactly as either political party would wish on their own. A divided Congress can increase the difficulty in predicting when legislation may pass and when such legislation may first be effective. Even within the House or Senate, the party in power must deal with the differences of opinion within their own ranks. A slim majority in the Senate may not be enough to overcome a minority party filibuster which further limits potential success of any particular piece of tax legislation.
New Tax Law in 2021?
With all the uncertainty of working with Congress and the President, there is still a good possibility of new tax law in 2021. If some or all of Biden’s proposals are passed into law, the next question to ask is when might the law become effective? Generally tax laws are effective as of the date signed by the President, or provisions take effect on the first day of the next tax year. This approach gives taxpayers time to plan and take actions before the new law begins. TCJA largely followed this approach, but since the law was signed on December 22, 2017 there was very little time for taxpayer to plan or take action before the law was effective on January 1, 2018. There have been two recent instances of retroactive changes to tax rates. In 1993 the 39.6% tax rate was enacted in August but was applied retroactively as of January 1. In 2001 a reduction of individual tax rates passed in June was made retroactive to January 1 of that year.
2020 Year End Tax Planning
Taxpayers that believe Biden’s proposals will increase tax rates and broaden the income tax base in 2021, can take these steps now to increase taxable income in 2020 and reduce taxable income in 2021.
- Accelerate income into 2020. For closely held businesses, increase invoicing, push collections of receivable, and accelerate work from January 2021 into December of 2020. For individuals and fiduciaries, harvest gains, ask for bonuses to be paid early, opt out of installment sales, avoid like-kind exchanges; take distributions from taxable retirement plans. If a sale of property or a closely held business is already underway, close the transactions before year end.
- Defer deductions into 2021. For businesses, elect out of bonus depreciation, put off equipment and supplies purchases and defer repairs until 2021, pay accrued bonuses after March 15, 2021, defer payment of accrued liabilities, and reduce retirement plan contributions. For individuals and fiduciaries, defer charitable contributions, medical expenses and tax payments until 2021, don’t fully fund deductible retirement savings or health savings accounts, and make contributions to ROTH IRA or ROTH 401(k) plans, if available.
- Gifts and estate planning. Take full benefit today of the $11,580,000 per person life time exclusion amount by funding gifts to trusts for the benefit of spouses, children, charities and others.
For all taxpayers, end of year tax planning is an opportunity to review current year results so far, project activity to the end of the year and develop expectations for income and taxes in the next year. A new President and potential for tax legislation in 2021 must be taken into account along with the whole financial situation of an individual, business or trust. And in 2020, the CARES Act tax related incentives and the impact of the coronavirus must also be considered. In the midst of options opportunities and uncertainties, your Cherry Bekaert tax professionals are ready to work with you to develop a strategy to optimize your tax position through the end of 2020 and beyond.
