The November 3rd election could have a dramatic impact on income and estate tax laws. These changes could take effect as early as January 1, 2021. Of course, the outcome of the election is a great deal of uncertainty and whether Democrats or Republicans will control the White House, Senate, and House. We will leave speculation on this subject to others – and remember that in every situation there is always the possibility of additional “October surprises”.
Since the Democrats are the party without power, tax policy can change dramatically if, in addition to their control of the House, they “run the table” and take control of the White House and Senate. Former Vice President Joe Biden has released a tax plan that would raise taxes significantly for high net worth individuals. Click here for a quick look at Biden’s suggestions.
For individuals and companies considering tax planning, the effective date of a tax increase or change in the deduction system is a key issue. In situations where taxpayers have control over the timing of income and deductions, taxpayers may be able to effectively “choose” their income tax rates – those currently in effect in 2020, 2021, or beyond. Making that “choice”, however, would mean accelerating income and paying income tax earlier than usual (this means giving up the benefit of deferring income tax, which is the best way to lower a taxpayer’s effective tax rate). Additionally, it can mean making tough decisions sooner than they would otherwise from a business perspective. For tax reasons, for example, it may make sense to sell a related company before the end of the 2020 calendar year. However, this poses significant logistical and business hurdles, especially given the possibility that businesses and the economy in general could recover in 2021 a higher net sales price.
From the election results, a taxpayer knows who at least some of the tax reform actors will be. However, if the Democrats do a clean deal, a taxpayer who makes an income acceleration decision in late 2020 should weigh not only what parts of the Democratic Plan will be passed, but also how quickly provisions will be passed. The benefit of waiting not only provides another year of income tax deferral, but also the benefit of being able to glean business prospects and possibly some key insights into which proposals will be adopted, as opposed to campaign rhetoric.
The newly elected President will take office 20 days after the New Year starts on January 20, 2021, and the new Congress will meet on January 3, 2021. If a new president is elected, Congress will likely wait to take office and pass new laws. In addition, Congress needs time to get organized and pass bills. But Congress can and has passed tax laws that have been effective retrospectively (at least for a limited period of time), and such laws can stand up to a challenge for constitutional reasons. Pension Benefit Guarantee Corporation v RA Gray & Co., 467 US 717 (1984); United States v Carlton, 512 US 26 (1994).
In the past, many tax rules were in effect at the time the provision was introduced to the committee because it was believed that the introduction of a bill would alert taxpayers to a change, but taxpayers ‘taxpayers’ liability to make the change was limited to plan.
Instead, whether Congress enacts certain tax laws retrospectively January 1, 2021 (or at some point in 2021) is a little more practical – whether Congress and the president can sign a tax bill early enough for policy changes to be included on IRS forms and software before large numbers of taxpayers start filing their tax returns for 2021. One example was in 2018 when the GOP declined after the Tax Cuts and Jobs Act was passed in 2017 and unexpectedly passed an Extender Act in early 2018 that extended certain tax rules to January 1, 2017. These extenders required some taxpayers to file amended and adapted tax returns, even though the extenders only affected a limited number of taxpayers.
Another possible restriction on retrospectively enacting tax laws by January 1, 2021 (or any other date in 2021) is the transition rule. In general, Senate rules dictate that 60 votes are required to pass laws directed against filibusters, and Democrats almost certainly won’t control 60 Senate seats. To avoid this requirement when passing the Tax Cut and Employment Act, Republicans used a process known as “reconciliation” in 2018, which avoids the 60-vote requirement. However, reconciliation can only be used three times during a fiscal year – and in practice it is typically used only once. The lack of reconciliation is a limiting factor in passing tax reform as the Senate Democrats have different priorities.
It is not clear that the Democrats would be constrained by reconciliation. In part in response to the Republican plan to replace the late Supreme Court Justice Ruth Bader Ginsburg, Democrats are seriously considering getting rid of the filibuster on legislation, though some moderate Democratic senators have not yet announced their support. Eliminating the filibuster would allow Democrats to avoid the process of reconciliation for key laws as they could pass all laws by their simple majority. Eliminating the legislative filibuster rule requires just 50 votes, with the vice president breaking the tie. There may be some traditionalist-democratic senators who support the preservation of the rights of the Senate minority and would vote against the elimination of the filibuster.
At the top of the Democrats’ list of priorities is the repeal of the provisions of the Tax Reduction and Employment Act that cut taxes on high-income individuals and businesses. This is a priority that most Democrats share. However, members of the Democratic Caucus disagree on proposed tax policy agenda items that go well beyond repealing the Tax Cuts and Employment Act, such as taxing capital gains and dividends at the same rate as normal income for taxpayers over 1 million US dollar income. Although the Democrats could win a Senate majority, it will be because relatively moderate Democrats wore red-toned states like North Carolina. Such large tax increases may not be popular with these senators, whose votes can be critical to getting it passed. In addition, some senators who otherwise generally support tax hikes will want to wait for the economy to recover.
The disagreements within the Democratic caucus may require more debate and negotiation over a grand plan to both repeal the TCJA provisions and implement some or all of the ambitious tax policy proposals on the Biden platform. While the Democrats are hugely supportive of tax reform, the new Congress will have significant challenges in responding to COVID-19, including tackling significant incentive efforts.
It is possible that after the filibuster was eliminated, Democrats could quickly band together on a proposal to repeal the TCJA provisions and provide for a limited increase in personal income and capital gains rates retrospectively in 2021 and then enact major reforms for further tax legislation in 2022.
Least likely for possible policy outcomes would be the adoption of a comprehensive tax reform proposal that implements large tax increases for wealthy individuals and businesses and is adopted and signed in time to prepare the tax returns and instructions that taxpayers can use to file their tax returns under the new tax rates in 2022. Given the logistical hurdles of both an agreement within the democratic assemblies of the House of Representatives and the Senate as well as the practical requirements for implementation, this seems unlikely.
Whether in 2021, 2022 or later, when Democrats take over the House, Senate, and Presidency, there will almost certainly be tax reform and income taxes for high net worth individuals and corporations will rise. Our observers see the end result somewhere in the middle between a repeal of the TJCA and the Biden proposals: the effective long-term capital gains rate increases (maybe just a redefinition of “long-term” and probably some interest rate changes, not the preferential rate for capital gains and dividends will be completely eliminated , and at least some deductions are limited (possibly with the reinstatement of the pease limit or a negative adjustment and the loss of the QBI deduction). The state and local tax deduction is reintroduced, and the charitable deduction is protected and maybe even expanded. The bottom line would be a tax reform that is far removed from the “significant” progressivity promised in the current Biden proposal, but still an interest rate hike.
With estate taxation, observers see little in the way of additional reform beyond the TCJA repeal, which could be quick and includes loss of the double gift and exemption from estate tax. The estate tax hike may be popular in a particular branch of the Democratic caucus, but there is a realization that the relatively low level of revenue compared to other revenue streams isn’t worth the internal struggle. The increase in inheritance tax will raise unpopular problems (family businesses, the definition of “small business”, vacation homes) to make changes to inheritance tax that are not worth the debate. While this may be the case, customers should consider estate tax planning before the end of the year.