Game plan now for potential higher taxes
Whether or not you believe the polls, it’s evident that the November 2020 election may usher in a change in the executive and legislative branches that could result in higher taxes for many. As a result, it makes sense for tax professionals to plan and take any actions that might be available to lessen potential adverse effects on their clients.
New presidents typically do get their tax plan enacted during their first year, according to Mark Luscombe, a CPA, attorney, and principal analyst for Wolters Kluwer Tax & Accounting.
“They have a pretty good record of getting things through during their first year in office,” he said. “If Biden wins and gets his tax plan enacted, it’s likely that it will bring higher taxes. But assuming it’s passed in 2021, any legislation probably won’t be effective until 2022. Congress seems to be hesitant to make tax hikes retroactive.”
Among other items, a tax increase proposed by Biden would restore the 39.6 percent rate for income over $400,000, and the elimination of capital gains treatment and qualified dividend preference for income over $1 million, Luscombe noted, adding, “He would also limit total itemized deductions so they do not exceed 28 percent. People in brackets over 28 percent would basically not get more than 28 percent of the benefit of itemized deductions.”
Taxes either way
Whoever wins the presidency, it is likely that higher taxes are in the offing, predicted Glenn DiBenedetto, a CPA and director of tax planning at New England Investment & Retirement Group.
“It seems inevitable with COVID that we’re looking at a potential raise in taxes,” he said. “California has proposed an increase in their tax rates via a progressive surcharge on seven-figure earners which would increase the tax rate on the highest bracket from 13.3 percent to as high as 16.8 percent in 2021, retroactive to the first of the year.”
The potential return to the pre-Tax Cuts and Jobs Act rates — which is slated to occur in 2026 even if not accelerated by the election results — makes tax bracket planning even more necessary for 2020, according to DiBenedetto: “It is important to project what bracket a taxpayer will be in two or three years from now. A lot of high-income people might look at accelerating income into 2020 in the event there is any political change.”
“Also consider maximizing the 2020 distributions from retirement accounts to take advantage of the benefits of a lower tax bracket,” he suggested. “For example, you could take a distribution in 2020 despite potentially having required minimum distributions waived under the SECURE Act.”
Current long-term capital gains and qualified dividends are taxed at 0 percent, 15 percent, or 20 percent, based on taxable income, he noted. “Taxpayers should review harvesting long-term gains to lock in the current low rates which will potentially increase,” DiBenedetto said.
The 12.4 percent Social Security tax for income above $400,000 would take a real bite out of the income of wealthy individuals, he observed. “Long-term capital gains and qualified dividends would be subject to tax at the ordinary income rate of 39.6 percent for those with income over $1 million, and the step-up in basis at death would be eliminated. Moreover, estate taxes would be headed higher with the reduction in the lifetime estate and gift tax exemption significantly reduced from its current amount,” he said.
“Estate taxes currently apply to the amount an estate’s value exceeds $11.58 million for a single person or $23.16 million for couples,” he said. “Although they are scheduled to sunset in 2026, given the mounting pressure to increase taxes, these exemption amounts could be lowered before they sunset.”
Therefore, DiBenedetto advised, “If a taxpayer is considering making a gift that would use up part or all of the exemption, now is the time to do it.”
Tate Taylor, a partner and chair of the private client services practice at Tampa-based Trenam Law, agreed. “The planning that we’re doing targeted to the high-net-worth community has its eye focused on elements of the Biden tax plan that would reduce the lifetime estate and gift tax exemption from its current level to those in place in 2009,” he said. “That $8 million difference in exemption amount currently translates into about $3.2 million in estate tax. People have started this year, if they have enough money, to make large gifts during life that would use up that exemption now, while it’s still available.”
Trust in trusts
One suggestion made by a number of professionals is to transfer assets to an irrevocable trust in return for a promissory note. If Biden wins the presidency, the transferor would forgive the promissory note.
“If Biden wins you’re locking in a gift by forgiving the note,” explained DiBenedetto.
“It’s a viable option,” agreed Taylor. “A lot of planners are doing this. It’s a way to put yourself in the position of making a last-minute decision of whether or not you want to pull the trigger. You can make a gift at the stroke of a pen at the end of the year.”
The other major policy shift in the Biden tax plan is the elimination of the step-up in basis at death, which allows heirs of the deceased to sell assets using the same basis that the decedent had.
“It’s something to take into consideration when making the decision as to when to sell assets,” said Taylor. “You can’t plan for death, but you can, in your investment priorities methodology, take into account the fact that the heirs might not have the same basis as the decedent when they go to sell the asset they inherit. It may be advisable to sell the asset before death to wipe out any gains to the heirs.”
“In a lot of ways, right now is a good time to do transfer tax planning,” agreed Ed Renn, senior equity partner at international law firm Withers. “With the exception of the stock market, we generally have depressed asset values. We’re seeing significantly less appetite for risk, resulting in bigger discounts for marketability. To put a number on it, if you expected a 30 percent discount in January 2020, it would be at 45 percent now.”
“The reality is that planning is not a simple process,” Renn said. “If you want a particular child to run a business, that has to be addressed now.”
And there’s no certainty that any increases won’t be retroactive to Jan. 1, 2021, Renn cautioned. “There are only 59 days between the election and Jan. 1, 2021,” he said. “A ‘blue wave’ — the White House, Senate and House all going to the Democrats — could result in increased rates effective as of that date. If the Republicans hold on to enough Senate seats, this won’t happen, but if the Democrats take everything, there will be a major reset in the way taxes will be handled and who will pay them.”
For details of the presidential candidates' tax policies for individuals, see our comparison.