Reproduced with permission from Copyright 2020 The Bureau of National Affairs, Inc.
We’re nearing the end of the 2020 calendar year (thank goodness!) And it’s time to start thinking about year-end tax planning. Because of the election result, there is much greater certainty about the possibility of short-term changes in tax law (even if control of Congress remains undecided) and the availability of a vaccine. This increased security (if not complete) is helpful.
The chances of the substantial tax hikes proposed by the Democrats during the election campaign for high-income taxpayers appearing into law next year seem very slim. It is also unlikely that the 2017 Tax Reduction and Employment Act will be repealed entirely. It is even less likely that material tax changes can be made retrospectively as of January 1, 2021.
When President-elect Biden takes office, he will do so with a slimmed-down house majority and a likely Republican majority in the Senate. Republicans will retain their majority if they can win any of the Georgia runoff elections (where they are favored by experts and betting markets). Even if Democrats in Georgia could win two runoff elections, Democrats would have a very weak majority of 50 Senators plus Vice President Harris as a tie. Even if the Democrats use the reconciliation process to postpone tax legislation, it would give any Democratic senator a veto on the legislation. Without the reconciliation process, passing it would require 60 votes to prevent a filibuster, a rule that is likely to remain in place for now.
However, a divided government does not mean that there will be no tax changes. Because the President and Congress focus on other areas of legislation, they can offset expenses with tax changes (like the SECURE Act provisions that changed the rules for inherited IRAs). There is a quota of the Democratic Caucus that supports tax increases (and aggressive tax collection efforts) for high net worth individuals. It is unclear how this will play out in legislation.
As of this writing, President-elect Biden has announced former Fed Chair Janet Yellen as his election for Treasury Secretary. Yellen was seen as a consensus decision that was less likely to immediately take an aggressive approach to regulation and management than others that were considered. It remains to be seen who will be filling lower-level appointments (appointments that could have more impact on the IRS approach to regulation).
All of this means a pretty standard approach to year-end planning:
Income tax planning. The proposed increase in the long-term capital gains rate from 20% to 39.6% for high-income taxpayers (and additional social security taxes) is not very likely in 2021, although a new administration and Congress may seek to generate revenue from small changes to the preferred Capital Gains Rate or other tax regulations. Given the relatively small likelihood that taxes will rise in 2021, any benefit from accelerating income to 2020 (to “tie” the 20% capital gain rate in 2020) appears to be offset by the disadvantage of paying income tax early (and lose the procrastination).
Instead, the standbys of income tax planning apply: crop losses now, postponement of profits (and taxes) until later. Hopefully, in March and April, taxpayers were proactive with crop losses (or there may not be many crop losses).
In recent years, taxpayers in states with high income taxes have considered moving their homes to a state with low income taxes. With recent Supreme Court rulings, it may also have become attractive to postpone the management of trusts in order to avoid state income tax. The value of that planning may be jaded as President Biden is likely to seek to reintroduce federal withholding for state and local taxes. On the other hand, the financially troubled states are likely to raise their state income tax rates. Arizona used to be considered an income tax haven, but Proposition 208 was passed, raising the highest state income tax rate to 8% on incomes over $ 250,000. Illinois has not passed the constitutional amendment required for tiered income tax, and state income tax will remain at 4.95% at this point.
For non-profit-minded taxpayers, the CARES Act provides a year-long opportunity to offset all taxable income with a cash gift for charity, provided the contributions are made to organizations other than 501 (c) (3) as non-corporate private foundations, donor-advised funds and supporting organizations. The wording of the law states that the CARES Act allows taxpayers to make contributions of valued property and contributions to private foundations and donor advised funds under the usual AGI restrictions, and then to make additional monetary gifts to nonprofits to get the 100% AGI -Deduction to use. Taxpayers can choose to apply the usual restrictions and carry over excess contributions to a future year. (Depending on the situation, this may be better if the taxpayer can use the deduction to offset ordinary income in future years as opposed to long-term capital gains in the current year.)
For taxpayers looking to protect capital gains, the IRS has extended the deadline for reinvesting capital gains in an opportunity zone to the end of the year. Depending on the details, a taxpayer could defer their capital gain for five years (through 2026) and permanently eliminate 10% of the capital gain if the investment in the Opportunity Zone is held for five years. The taxpayer will also enjoy tax free growth on the underlying OZ investment itself if held for 10 years.
If 2020 is going to be a loss year, a taxpayer may want to accelerate deductions through 2020 to take advantage of the loss provisions of the CARES Act, which remove the damage limits imposed by the TCJA. CARES has suspended the excessive business loss rule for tax years prior to January 1, 2021 (the excessive business loss limit prevents non-corporate taxpayers from claiming net business losses above a threshold). In addition, the net operating loss restrictions will be suspended for tax years prior to January 1, 2021 (such losses can be repaid for five tax years without the 80% limit on such losses).
Estate tax planning. Given that the Senate is Republican-controlled or 50% split with a vice presidential tie-breaker, the additional gift and estate tax exemption (now $ 11.58 million) is unlikely to be lifted. The exemption is expected to decrease to $ 5 million in 2026 (the exemption will likely be closer to $ 6 million when adjusted for inflation). While it looks like the additional exemption amount will last through next year, low valuations and interest rates keep it a historically opportune time to look into estate planning (low interest rates improve the efficiency of trust funds and installment sales of grantor trusts transfer assets to the next generation with no gift tax.
Despite major upheavals in 2020, general income tax planning remains the same: accelerate losses and deductions, postpone profits, and be proactive with inheritance tax.
This column does not necessarily reflect the opinion of the Bureau of National Affairs Inc. or its owners.