2020 Election Outlook - Planning for Potential Tax Changes
Who will win the Presidential Election and control congress? This is an important question for wealthy investors and taxpayers because it could have a major impact on their current and future tax bills. Because tax policy is so politically charged, neither candidate is likely to accomplish much without his party’s full control of congress. If Joe Biden becomes president and has a Democratic Congress behind him there could be extraordinary changes in tax policy. Based on Biden’s proposals these changes could mean significantly higher taxes for wealthy taxpayers. These taxpayers may want to contact their tax advisor and estate attorney now to discuss taking action.
The possibility for major changes to tax policy likely depends on the Democrats sweeping the White House and Congress. If Trump is re-elected or the Democrats and Republicans split the White House and Congress more gridlock is likely.
The Proposed Tax Plans
The Presidential candidates have shared fundamentally different proposals on government spending and taxes. The majority of the tax breaks for individuals enacted in 2017 with the Tax Cut & Jobs Act lapse after 2025. President Trump wants to extend them. Mr. Biden would keep the tax cuts signed in 2017 for households making less than $400,000.1 Specifically, Mr. Biden proposes the following changes to Federal taxes:2
Raise the top marginal tax rate back to 39.6% from 37%
Increase tax rates for long-term capital gains to ordinary income tax rates for those with incomes over $1mm
Increase payroll taxes to 12.4% on incomes over $400,000. Currently wages over $137,700 are exempt. Mr. Biden would keep that cap but then start the tax again at wages over $400,000
Repeal the 20% deduction for income from pass-through businesses
Impose limits on itemized deductions
Increase corporate tax rates to 28% from 21%
Restrict tax-free exchanges of real estate to those with incomes below $400,000
Introduce tax credits for lower and middle-income taxpayers including child care, buying a first home and more
The potential impact of Mr. Biden’s tax policies on wealthy taxpayers could be significant, with those at the top of the income scale seeing the largest increases. The Wall Street Journal estimated the potential increase in taxes on five different families under Mr. Biden’s tax plan.3 Their analysis shows that owners of pass-through businesses with high incomes could see the largest increases.
Source: “Where Trump and Biden Stand on Tax Policy” 9/17/20, Wall Street Journal
While each taxpayer’s situation is unique, it is clear that Biden’s tax policies are intended to significantly increase both income and payroll taxes on those earning more than $400,000.
Proposed Changes to Estate & Transfer Taxes
Biden also proposes a number of changes to estate and transfer taxes. This could have a large impact on families with balances sheets above $10mm. Biden’s proposals include:4
Tax unrealized gains at death as capital gains, removing the step-up in basis
Lower the estate tax exemption from $11.58mm per person to $5.49mm per person. Biden has not proposed increasing the 40% estate tax rate
These changes, if enacted, would significantly increase the amount of family assets subject to capital gains or estate taxes. Families with appreciated assets such as stocks, businesses, and real estate would pay capital gain taxes on those assets when a family member died rather than receiving them with a step-up in basis and avoiding capital gains taxes. Likewise families with more than $10mm in assets would have a larger portion of their estate subject to a 40% estate or gift tax.
(1) Illustration assumes a total taxable estate of $30,000,000 that includes an investment portfolio worth $18,000,000 with a cost basis of $8,000,000. The current law illustration assumes a taxable estate of $6.8mm taxed at 40% with no capital gains due at death. The Biden proposal illustration assumes a taxable estate of $19mm taxed at 40% with capital gains tax due on $12mm at 39.6%.
What Steps Can Taxpayers Take Now?
While the outcome of the election is uncertain taxpayers can take action now to address the threat of a change in tax policy.
To address the possibility of higher income and payroll taxes in 2021 taxpayers can consult with their tax advisors on the following options if Democrats win the White House and Congress. These strategies are intended to incur income, gifts, or capital gains in 2020 rather than subsequent years.
Take capital gains in 2020 by selling appreciated assets such as stocks or real estate
Pay income and business distributions in 2020
Exercise restricted stock or stock options in 2020
Sell your business in 2020
Convert a traditional IRA to a Roth IRA
Transfer assets to family members with lower marginal tax rates
Perform like-kind real estate exchanges in 2020
Consider investing in opportunity zones in 2020
Donate highly appreciated stock to a donor-advised fund or charitable trust in 2020
Accelerate charitable giving and itemized deductions into 2020
To mitigate the potential lower estate tax exemption and loss of the step-up of basis at death, families with more than $10mm in assets can consider making gifts to a spouse or child before the end of the year. The current estate tax exemption amount of $11.59mm is a “use it or lose it” opportunity. Families can make outright gifts or in trust and IRS rules prohibit any clawback.
Wealthy families can also take advantage of gifting strategies that benefit from low interest rates such as Grantor-Retained Annuity Trusts (GRATs) and Charitable Lead Annuity Trusts (CLATs). Specific strategies to consider include:
Make outright gifts to children or in trust before the end of the year
Consider using a Spousal Limited Access Trust (SLAT) to make gifts to a spouse that can help lower the amount of assets subject to estate tax
Consider gifting strategies that benefit from low interest rates such as GRATs or CLATs
Utilize family limited partnerships to gift appreciated assets to children
We encourage wealthy families to consult with their tax advisors and estate planning attorneys regarding their options as soon as possible. If they wait until the election is over their advisors may be too busy to help them with the necessary calculations and preparing legal documents. We recommend that families consider asking their Estate Planning attorneys to draft and finalize gifting documents for families to hold in reserve to see what happens with the election. To avoid overacting we recommend that families only consider gifting options that the family would be making in the future. Making gifts or transfer simply to avoid taxes can be a knee-jerk reaction and lead to poor choices.
The presidential election of 2016 taught us that the results of elections can be unpredictable. But taxpayers can take action now to prepare for whatever may occur. If you or someone you love needs help with these issues please contact us at info@summithillwealth.com to set up a complimentary consultation.
Disclosure:
Summit Hill Wealth Management does not offer tax planning or legal services, but may provide references to accounting, tax services or legal providers. They may also work with your attorney or independent tax or legal advisor.
All written content is for information purposes only. It is not intended to provide any tax or legal advice or provide the basis for any financial decisions. Please consult a qualified professional for assistance with any tax or legal issue to review the implications.
Sources
“Where Trump and Biden Stand on Tax Policy” 9/17/20, Wall Street Journal
Ibid
Ibid
“Biden’s Tax Proposals for Capital Gain, Like Kind Exchanges, Basis Stepup & The Estate Tax – Tough Times Ahead?” 8/17/20, JD Supra