Video: Post-Election Tax Speculation: Preparing for 2020 & Beyond December 28, 2020
Post-Election Tax Speculation: Preparing for 2020 & Beyond
Hello again, this is Blaine Carr and I am a Senior Wealth Advisor with Petersen Hastings. We are an independent wealth management firm with offices in Kennewick and Walla Walla, Washington. We are passionate about Fiduciary-Centered Advice and education to our clients, prospective clients, and community. Today I will cover Joe Biden’s tax proposal and how this might impact your tax situation in the near future.
According to his website, Joe Biden “will not raise taxes on anyone making less than $400,000. Period.” So, the really quick answer here is, expect your taxes to go up if your income exceeds $400k, and potential tax savings for those of you with income less than $400k. Most things in life aren’t that straightforward, especially anything to do with the U.S. Tax Code.
Before we dive into this further, I need to address the current political landscape. While a Biden Presidency is almost certain, and the Democrats have control of the House of Representatives, the Senate is still up for grabs with a run-off election for both seats in Georgia slated for January. If the Democrats win both of those Senate seats, they will have complete control, and you can pretty much expect most provisions in Biden’s tax proposal to become law. That scenario isn’t likely, which means there will probably be some compromise, and it will probably take longer for a Biden tax package to pass. At this juncture I’d say there won’t be any major changes to tax law that will that apply to 2021, but I also recommend holding off on your major 2021 tax decisions until next fall, especially if your income is anywhere near $400k.
Many of our current tax provisions, including tax rates, took effect in 2018 through the Tax Cuts and Jobs Act. Those provisions will expire after 2025, if Congress doesn’t vote to extend them. I will now cover some of the main aspects of Biden’s tax proposal. In doing so, I will show how the proposed tax provisions compare to current tax law, and what action you should consider.
First the individual tax brackets. We should continue to have 7 rate tiers with most of the tiers remaining similar to what we have today. The big change occurs when taxable income exceeds $400k. One major question is whether Biden’s reference to $400k of income applies to those filing Single or Married, and whether it is adjusted gross income or taxable income. Either way, it will lead to even higher tax rates for high income taxpayers. [Bulleted List 1] It doesn’t stop there. While most deductions are likely to remain in effect, these taxpayers will likely see a cap on the rate their itemized deductions receive. This means, income could be taxed at nearly 40% while deductions will produce only a 28% benefit. In addition, more Social Security tax will be assessed on wages and self-employment income exceeding $400k. Top capital gains rates would also double from a maximum 20% to nearly 40%.
One of the more unusual ideas Biden has is a change from employee 401(k) contributions generating a tax deduction to a credit. Currently, these contributions reduce taxable income at a taxpayer’s current tax rate. The proposal is to convert this to a 26% tax credit for everyone. This means those in the lower tax brackets will receive a higher tax benefit and those in higher brackets will get a lower tax benefit. This idea really leaves me scratching my head. For now, I would hold off on making changes. But, if this becomes law, I recommend switching to Roth contributions for those of you in the 32% bracket, and higher, if your 401k plan allows it, and if you expect high income during retirement.
All in all, taxpayers are likely to pay more than a 40% rate on income exceeding $400k. The marginal tax rate on an extra dollar of income could exceed well over 50%, when factoring in decreases of many deductions and credits. For those of you in this situation, consider accelerating income into 2020 and possibly 2021, as well as accelerating some personal deductions to 2020-21.
Biden’s tax plan does include benefits for individuals. The Child Tax Credit and the Child and Dependent Care Credit will be expanded to $3k and $8k, respectively, but the phaseout ranges for these benefits are likely to be lowered. For those of you who itemize their deductions, the current $10k cap on State and Local Tax deductions might be removed, resulting in increased deductions. In addition, tax relief would be offered for student debt forgiveness and the first-time homebuyer’s credit might be restored. I would also remind you of the proposed change to 401(k) contributions. Because this may take the form of a refundable tax credit, those in the 24% and lower tax brackets should switch your 401(k) contributions from Roth to Pre-tax in order to take full advantage of this credit if it becomes law.
Now to business taxes. The corporate tax rate decreased from 35% to 21% back in 2018. The goal was to make our high U.S. corporate tax rates more globally competitive. 21% is a fairly low tax rate and an increase to 28% is one of the least controversial items in Biden’s tax proposal. In addition, Biden is looking to bring back the corporate minimum tax to ensure corporations pay at least a 15% rate on book income, which affects those corporation with a lot of tax preference items. If you have a C-Corporation you should strongly consider accelerating some income into 2020 or deferring some expenses to the future in order to take advantage of the current 21% corporate tax rate.
The 199A tax provision made its debut in 2018 when C-Corporation tax rates were greatly reduced. 199A is a mechanism which equalizes the taxes paid by large corporations and small business owners. This is done by allowing a deduction of 20% of a business’ Qualified Business Income. The income from most small businesses is referred to as pass-through income because it is passed-through and taxed on the personal returns of the business owners. These businesses are formed as sole-proprietorships, partnerships, S-Corporations, and even estates or trusts. At this point it looks like Biden is in favor of retaining the 199A deduction on income below $400k. My general recommendation here is to accelerate business income into 2020 and push deductions out to the future in order to have receive more 199A deduction in total. Do be careful if your business is considered “non-qualified” because you might benefit more from pushing income out past 2020 or accelerating deductions into this year.
Let’s transition to estates. Very few estates pay federal estate tax, but more will likely do so in the near future. Biden would like to return to the 2009 rules, which would lower the federal exemption from $11.6 million to $3.5 million and raise the top estate tax rate from 40% to 45%. As a quick sidenote, don’t forget about estate taxes at the state level. Washington State is tied with Hawaii for the highest estate tax rate at 20%. Washington’s estate exemption is about $2.2 million. In addition, Biden is in favor of removing the step-up in basis rule. Currently, the beneficiaries of after-tax assets receive higher cost basis on those assets, which results in lower capital gains taxes in the future. Eliminating step-up in basis would increase future taxes on the beneficiaries all sizes of estates. I recommend continuing to make present gifts to beneficiaries and charities, as well as naming disclaimer trusts in your will, in order to reduce the size of your taxable estate. Individuals can gift up to $15k each year to other individuals without being subject to gift taxes. Those with higher net worth should consider gifting more than $15k annually in order to remove appreciating assets from their future estates. Charities can also benefit from gifts and you will also receive a current tax deduction for those, subject to charitable giving rules.
Okay, let’s wrap this up. There is a possibility that tax rules will not change in 2021. The target for tax increases appears to be on individual taxpayers with incomes exceeding $400k, C-Corporations, and Estates. Some individuals stand to receive larger tax deductions or credits from the Biden tax plan. This tax proposal will probably take some time to pass, and likely will not pass in its entirety. Whether you stand to win or lose, it is important for you to have a strategy. Your action plan might involve accelerating income and postponing deductions, or vice-versa. A Roth conversion might be beneficial, as would reviewing your estate plan and considering annual gifts to individuals or charities. Also, those of you who are contributing to 401(k) accounts should revisit whether it benefits you more to make those contributions on a Roth or Pre-tax basis.
As always, do check with your experienced tax advisor, wealth manager, or attorney prior to taking action. I hope you enjoyed this video so much that you share it with your family and friends. Also, I encourage you to visit our website at www.petersenhastings.com. Bye for now!