11.30.20 | Client Alert
Even though the Presidential election is behind us, with future control of the Senate presently unsettled, there is still much uncertainty about what tax legislation will look like and when changes will be effective under a Biden administration. The earliest we may know the general direction is January 5, 2021 when the two Georgia Senate run-off races take place. If the Republicans win and retain control of the Senate, a tax overhaul is unlikely to be achieved by President-elect Biden without some bipartisan support. If the Democrats win both Georgia Senate seats, it’s still not clear that tax changes will be imminent. With the economic recovery underway, the rising COVID-19 cases across the nation, and the pressure for another COVID-19 stimulus deal, it has been speculated that major tax changes, particularly tax increases, will not be viable until 2022 or later. Nevertheless, high-income taxpayers with substantial net worth may still want to consider moving ahead with year-end tax and estate planning. Further details are discussed below in this client alert.
Individual Income Taxes
It is no secret that income taxes will likely increase for high income taxpayers under President-Elect Biden’s revenue-oriented tax plan. Increases to the top marginal tax rate, as well as the reduction or elimination of many provisions enacted by the Tax Cuts and Jobs Act of 2017 (TCJA) for taxpayers with income over $400,000, is the driving force of such proposed tax increases. Understanding current and proposed tax law is essential for your 2020 year-end tax planning.
Currently, the top marginal income tax rate is 37%, with preferential rates for qualified dividends and long-term capital gains at 23.8% (20% income tax + 3.8% net investment income tax). A social security tax of 12.4% (employer/employee portion) applies up to $137,700 of wages or self-employment income. For those taxpayers that itemize deductions, the maximum combined state/local/property tax deduction is $5,000 single/$10,000 married filing jointly (MFJ). Total allowable itemized deductions receive a dollar-for-dollar credit against an individual’s adjusted gross income. Individuals with certain types of business income and REIT dividends receive up to a 20% deduction against this income, effectively lowering the top income tax rate on qualified business income to 29.6% (37% x 80%).
President-Elect Biden’s tax plan calls to increase the top marginal rate to 39.6% for individuals with income over $400,000. Qualified dividends and long-term capital gains would be taxed at 43.4% (39.6% income tax + 3.8% net investment income tax) for income over $1,000,000. The application of the social security tax would follow a donut-hole concept in which wages up to $137,700 would be taxed as well as wages above $400,000. Itemized deduction reform includes lifting the $5,000 ($10,000 MFJ) cap on state/local/property tax deductions, curtailing the tax benefit of deductions to 28% for those taxpayers in a 28% or higher tax bracket, and further reducing itemized deductions by 3% of adjusted gross income in excess of a certain threshold (restore Pease limitation). The tax proposal looks to eliminate the 20% qualified business income deduction for those individuals with over $400,000 of income.
What does this mean for 2020 year-end income tax planning?
Plan ahead to take advantage of the guaranteed lower tax rates in 2020 and higher tax benefits for itemized deductions. If there are certain items of income expected to be realized, or deduction items expected to be paid in 2021, it may make sense to accelerate one or more of these actions if it’s in your control.
Where it makes sense to do so, the following are some options for year-end income tax planning:
- Accelerate wage bonuses, capital payouts, sales of securities, and sales of business interests or real property before the close of the year.
- Accelerate the payment of charitable commitments to 2020. Under the CARES Act, the limit on cash charitable deductions to public charities was increased from 60% to 100% of adjusted gross income (AGI) for donations made in 2020. The limit on non-cash contributions to charitable organizations remains unchanged at 30% of AGI.
- Defer the payment of state/local/property taxes to 2021, which may result in a larger deduction in 2021 due to the current cap.
- Pay outstanding interest expense on home loans and investment loans prior to year-end to maximize the tax benefit of these deductions.
For a more in-depth analysis of President-Elect Biden’s income tax proposals, click here.
Estate and Gift Taxes
President-Elect Biden’s tax plan may have a dramatic impact on a high net worth individual’s estate plan. There is much uncertainty as to whether such changes will get passed by a divided senate and if so, whether change will occur in 2021 or sometime after. However, planning for potential estate tax reform is important to consider prior to the close of the 2020 tax year. The COVID-19 impact on decreasing asset values in certain businesses, as well as historically low interest rates have proven beneficial for estate and gift tax planning during the 2020 tax year.
The current $11,580,000 estate, gift and generation-skipping transfer (GST) tax exemption is scheduled to maintain this level (indexed for inflation) through the end of 2025, when the TCJA expires. Gifts made today are protected by the “anti-clawback” regulations, which allow individuals to use the current exemption without fear of future penalty or “clawback” at the taxpayer’s death. To the extent the combination of a decedent’s estate and lifetime gifts (above annual gift exclusions) exceed the exemption, there is a 40% tax. Beneficiaries of estate assets receive a step-up in basis equal to the fair market value of the assets on the date of death.
President-Elect Biden’s tax plan looks to dramatically decrease the estate, gift and GST exemption to $5,000,000 (possibly as low as $3,500,000), with no index for inflation, as early as 2021. The decreased exemption is coupled with an increased estate, gift and GST tax rate to 55%. Further, there is a proposal to remove the step-up in basis at death, with uncertainty as to whether this would result in an income tax at death on unrealized appreciation, or a carryover of the decedent’s basis to estate beneficiaries.
What does this mean for 2020 year-end estate, gift and GST tax planning?
With potentially significant changes to the estate, gift and GST tax law, high net worth individuals should be proactively working with their advisors to understand how their estate plan may be impacted. Establishing a plan to use the remaining estate, gift and GST exemption prior to the close of the year may be optimal.
Where it makes sense to do so, the following are some options for year-end gift and asset transfers:
- Gift or sell assets to a GST exempt intentionally defective grantor trust (IDGT). This works especially well with the transfer of minority interests in real estate or other business assets that will reflect valuation discounts. Sell assets with a note reflecting current historically low interest rates.
- For those concerned about permanently giving away assets to younger generations, gifting to a Spousal Lifetime Access Trust (SLAT) preserves distributions to spouses, thereby maintaining access to the trust.
- Gift cash to IDGT or SLAT to maximize the 2020 exemption and then exercise the grantor trust SWAP power to exchange the cash for assets at a later date.
For a more in-depth analysis of President-Elect Biden’s Estate, Gift and GST tax proposals, click here.
For C corporations, Biden’s plan would increase the current 21% flat tax rate to 28%, with no clarity to date on whether it would be graduated or flat. Nevertheless, the standard approach in a rising tax rate environment of accelerating income and deferring deductions, where possible, holds sway. This may be more feasible for cash method taxpayers than accrual. For pass-through entities, many of the concepts discussed above applicable to individual taxpayers will apply at the pass-through entity level. Under a Biden driven tax reform, the fate of capital spending incentives, such as accelerated depreciation, are uncertain. Therefore, where possible, accelerating such plans seems prudent.
For a more in-depth analysis of President-Elect Biden’s business tax proposals, click here.
In a difficult planning environment such as this, there is clear merit to going through the planning process in order to evaluate all options and planning strategies available to you. The decision to act this year depends on factors personal to each situation. We recommend that you consult with your trusted advisors to implement an action plan that suits your specific needs.
Your Berdon tax advisor is following these developments daily and, as always, is available to have a discussion tailored to your personal situation. We also encourage collaboration with your other professional advisors to ensure that your planning needs are addressed in a coordinated manner.
Berdon LLP New York Accountants