Even though the presidential elections are behind us and future control of the Senate is still unclear, there is still great uncertainty about what the tax legislation will look like and when changes will take effect under a Biden government. We know at the earliest that the general direction will be January 5, 2021, when the two Georgia Senate runoff elections take place. With Republicans gaining and maintaining control of the Senate, President-elect Biden is unlikely to get a tax overhaul without bipartisan support. If the Democrats win both seats in the Georgia Senate, it is still not clear that tax changes are imminent. Given the economic recovery, rising COVID-19 cases across the country, and pressure for another COVID-19 business cycle deal, it has been speculated that major tax changes, especially tax increases, will not be feasible until 2022 or later. Still, high-income taxpayers with significant net worth may still want to consider moving forward with year-end tax and estate planning. Further details are provided below in this client alert.
Individual income taxes
It’s no secret that income taxes for high-income taxpayers are likely to rise under President Elect Biden’s income-oriented tax plan. The driving force behind such proposed tax increases are the increase in the highest marginal tax rate and the reduction or elimination of many provisions of the Tax Cuts Jobs Act (TCJA) for taxpayers with incomes in excess of $ 400,000. Understanding current and proposed tax law is critical to your 2020 year-end tax planning.
Currently, the highest marginal tax rate is 37%, with the preferential rates for qualified dividends and long-term capital gains being 23.8% (20% income tax + 3.8% net investment tax). A social security tax of 12.4% (employer / employee) applies up to $ 137,700 in wages or self-employment income. For those taxpayers who declare deductions, the maximum combined state / local / property tax deduction is $ 5,000 for individual / $ 10,000 MFJ. Total Allowable Individual Deductions receive a dollar-for-dollar loan on an individual’s Adjusted Gross Income. Individuals with certain types of business income and REIT dividends receive up to a 20% deduction from that income, effectively lowering the top qualified business income tax rate to 29.6% (37% x 80%).
President-elect Biden’s tax plan is to raise the top marginal rate to 39.6% for those earning over $ 400,000. Qualifying dividends and long-term capital gains would be taxed at 43.4% (39.6% Income Tax + 3.8% Net Investment Income Tax) for income above $ 1,000,000. The application of social security tax would follow a donut hole concept, taxing wages up to $ 137,700 and wages above $ 400,000. The individual withholding reform includes removing the $ 5,000 (10,000 MFJ) cap on state / local / property tax deductions, reducing the tax benefit of deductions to 28% for taxpayers in a tax bracket of 28% or more, and further reducing individual withholding by 3 % of adjusted gross income above a certain threshold (restoration of the pease limit). The tax proposal aims to remove the 20% qualifying business income deduction for individuals with incomes over $ 400,000.
What does this mean for income tax planning at the end of 2020?
Plan ahead to take advantage of guaranteed lower tax rates in 2020 and higher tax breaks for individual deductions. If there is certain revenue or anticipated deduction to be paid in 2021, it may make sense to speed up one or more of these actions if you are in control of them.
Where this makes sense, the following are some options for year-end income tax planning:
- Accelerate wage awards, principal disbursements, stock sales, and business or property sales before the end of the year.
- Accelerate the payment of charitable obligations by 2020. Under the CARES Act, the limit on charitable deductions to charitable organizations has been increased from 60% to 100% of the adjusted gross income (AGI) for donations in 2020. The limit for contributions in kind Contributions to non-profit organizations remain unchanged at 30% of AGI.
- Postpone paying state / local / property taxes to 2021, which may result in a larger deduction in 2021 due to the current cap.
- Pay off outstanding home loan and investment loan interest payments before the end of the year to maximize the tax benefit of these deductions.
Click for a more in-depth analysis of President-Elect Biden’s income tax proposals Here.
Estate and gift taxes
President-elect Biden’s tax plan can have a dramatic impact on a wealthy individual’s estate plan. There is great uncertainty as to whether such changes will be passed by a divided Senate and, if so, whether changes will occur in 2021 or sometime after. However, planning a possible inheritance tax reform must be taken into account before the end of the 2020 tax year. The effects of COVID-19 on declining assets in certain businesses, as well as historically low interest rates, have proven beneficial for estate and gift tax planning in the 2020 tax year.
The current tax exemption for estate, gift, and generational transfers (GST) of $ 11,580,000 is expected to maintain this level (inflation-indexed) through the end of 2025, when the Tax Cuts Jobs Act (TCJA) expires. Gifts made today are protected by “anti-clawback” regulations, which allow individuals to take advantage of the current exemption without fear of future penalties or “clawback” upon the taxpayer’s death. To the extent that the combination of a deceased person’s estate and lifelong gifts (beyond the annual gift exclusions) exceeds the exemption, a 40% tax is levied. Beneficiaries of inheritance assets receive a base increase equal to the fair value of the assets at the time of death.
President-elect Biden’s tax plan is to drastically reduce the estate, gift and GST exemptions to $ 5,000,000 (possibly just $ 3,500,000) without an inflation index as early as 2021. The reduced exemption is associated with an increase in the estate, gift and tax exemption GST tax rate to 55%. It is also proposed that the death base increase be lifted, with uncertainty as to whether this would result in death income tax on unrealized appreciation or a transfer of the deceased base to the beneficiaries.
What does this mean for estate, gift and GST tax planning at the end of 2020?
In light of potentially significant changes in estate, gift, and GST tax laws, high net worth individuals should proactively work with their advisors to understand how their estate plan may impact. It may be best to have a plan for using the remaining estate, gift, and GST exemption before the end of the year.
Where appropriate, the following are some year-end gift and asset transfer options:
- Donate or sell assets to a GST exempted intentionally defective Grantor Trust (IDGT). This works particularly well when transferring minority interests in real estate or other business goods that reflect haircuts. Sell assets with an indication that reflects the current historically low interest rates.
- For those concerned about permanently passing assets on to younger generations, donating to a Spousal Lifetime Access Trust (SLAT) will preserve distributions to spouses, thereby preserving access to the trust.
- Gift IDGT or SLAT cash to maximize the 2020 exemption, then exercise the Grantor Trust’s SWAP power to exchange the cash for assets at a later date.
Click for a more in-depth analysis of President-Elect Biden’s Estate, Gift and GST tax proposals Here.
For C-companies, Biden’s plan would increase the current flat tax rate from 21% to 28% without it being clear yet whether it would be graduate or flat. Nonetheless, in an environment of rising tax rates, the standardized approach is to accelerate income and defer deductions whenever possible. This may be more practical than the provision for taxpayers using the cash method. For pass-through companies, many of the concepts discussed above apply to individual taxpayers at the pass-through company level. As part of a tax reform driven by Biden, the fate of investment incentives such as accelerated depreciation is uncertain. It therefore seems advisable to speed up such plans whenever possible.
Click for a more in-depth analysis of President-Elect Biden’s corporate tax proposals Here.
In a difficult planning environment like this, it clearly makes sense to go through the planning process to evaluate all of the options and planning strategies that are available to you. The decision to act this year will depend on the personal factors for each situation. We encourage you to get in touch with your trusted advisor to implement a plan of action that meets your specific needs.