TAX PLANNING MOVES
With ever-changing tax laws, long-term planning can feel like you are aiming at a moving target. This year, with the uncertainty of the 2020 elections and the potential tax law implications, it is more akin to aiming at that moving target while wearing a blindfold.
Vice President Biden has outlined tax policy changes he would pursue as President. Should he win the election, and should the Democrats win control of the Senate, some measure of change is almost certain. Below, we highlight some key areas of Vice President Biden’s tax plan and discuss some strategies to consider as we approach the end of 2020.
A Few Items to Consider:
- This tax plan was first proposed by Vice President Biden as part of the Democratic primary race and before the economic impact of COVID-19 was known. It is unclear whether the changing landscape will affect this plan or the timing of its implementation.
- Even if Vice President Biden were to win the Presidency and the Democratic party were to assume control of the Senate, some provisions of the plan may not win full Democratic support.
- It is not clear whether any changes in tax policy would be retroactive to the beginning of 2021, although that is our assumption.
- The intent of this update is not political. Rather, we are looking at the proposed areas of change within the tax plan, helping you understand the potential impact to your wealth, and helping you identify strategies to lessen that impact.
- We are not giving tax or legal advice and we encourage you to discuss these matters with your legal and tax professionals.
Key Components of Vice President Biden’s Proposal
- The highest income tax rate would revert to the pre 2017 tax rate of 39.6% (up from the current 37% tax rate passed as part of the 2017 tax cuts).
- The 12.4% Social Security tax (6.2% paid by the employer and 6.2% paid by the employee) would be levied on wages below $137,700 (current law) and above $400,000 (proposed). This would leave a gap between $137,700 and $400,000 where the tax would not be levied.
Strategies to Consider
- Where possible, those in the highest marginal tax bracket may want to accelerate the receipt of income into 2020. Further, those who are not in the highest bracket but who would be affected by the proposed increase in the Social Security tax, may also want to consider a similar strategy.
- Those who are debating whether to itemize deductions in 2020, may want to consider the benefit of using the standard deduction in 2020 and, where possible, paying 2020 deductible expenses in 2021. Although it is unclear how Vice President Biden would handle all itemized deductions under his tax plan, including whether the SALT (State and Local Tax) tax limitations will be relaxed (currently capped at $10,000), the plan does recommend restoring the PEASE limitation on itemized deductions (eliminated in the 2017 tax reform) for taxable incomes greater than $400,000 , as well as phasing out the qualified business income deduction, also for filers with taxable income greater than $400,000.
Capital Gains Taxes
- Capital gains would be taxed at ordinary income tax levels, up from the current tax rate of 20% on long-term capital gains. While the current proposal imposes this change only on those earning over $1 million per year, that dollar threshold for the increased tax rate is viewed by many as a soft target. Many believe that dollar threshold will be reduced to $400,000, coinciding with the income amount used for the re-application of the Social Security tax and the amount often used by Vice President Biden, in his Presidential campaign, as the income amount below which taxes will not increase. Note: the plan also recommends that qualified dividends be taxed similarly to capital gains under the new tax package.
Strategies to Consider
There are near-term and longer-term considerations associated with these portfolio taxes.
- It may be prudent to accelerate capital gains realization into 2020. We would limit this strategy to assets you intend on selling. Said differently, we would avoid selling assets simply for tax purposes. If, for whatever reason, the capital gains tax rate does not increase, you would limit the downside of this strategy to an acceleration of the taxes on assets you intend on selling, as opposed to added taxes you would have, otherwise, not incurred. Successful implementation may require action prior to the election, adding to the uncertainty. Executing this strategy after the election could be challenging as like-minded investors, selling in concert, could drive security prices lower.
- Longer term, a change to the Capital Gains rate will affect portfolio design as the frictional cost of taxes will increase. We are currently evaluating portfolio design implications, although given the potential disruption this could create within a portfolio, any adjustment to strategy would come as the result of actual tax policy changes.
A couple of provisions will require many to rethink their estate plans.
- The Lifetime exemption is currently $11.58 million per person ($23.162 million for a married couple) until January 1, 2026. This amount would be reduced considerably under the proposed tax plan. Most often discussed has been a range between $3.5 million – $5.6 million per person.
- Also proposed is an elimination of the cost basis “step up” at death. The step up affords the beneficiary of assets in the estate the ability to reset the cost basis of those assets to the asset’s market value as of the date of death. This allows beneficiaries to avoid the tax on any unrealized gains that existed at the time of death. Consider this example:
- The beneficiary receives $500,000 of Apple stock that was bought for $1. With no step up in basis (proposed plan), the tax liability would be $100,000, assuming a 20% capital gains tax rate. However, with a step up in basis (current), the beneficiary’s cost basis would be reset to $500,000, thereby avoiding the tax liability.
Strategies to Consider
Near Term | Lifetime Exemption Those who were planning on utilizing the current Lifetime Exemption before it expired in 2026, but have not yet done so, may want to give the matter consideration. If the exemption value is lowered, the amount not used above the new limit and below the current limit would likely be lost.
Longer Term| Basis Step Up A loss of the basis step up could have significant implications to estate plans, especially for those inheriting small businesses. This proposed change would also result in the beneficiaries of smaller estates (those below the lifetime exemption amount) owing taxes under the new regulations that would not have existed under the current regulations. Interestingly, for estates above the estate tax limit, the impact may be slightly positive. Assuming that those estates would not be required to pay both a capital gains tax and the estate tax on the unrealized gain, the estate may benefit if the capital gains tax rate is lower than the estate tax rate.
Other Strategies to Consider
IRA Roth Conversions The prospect of higher tax rates prospectively may make it advantageous to convert traditional IRA assets to Roth IRA assets. Factors to consider include, but are not limited to, your current tax bracket, your expected tax bracket throughout retirement, the availability of funds to pay the tax liability on converted amounts, your immediate need for use of the IRA assets, and the potential transfer of a remaining IRA balance at your death. Remember that Roth IRA conversions cannot be undone so if the benefit is marginal, this may not make sense.
Any change to an individual’s current strategy needs to weigh the risks of action with the risks of inaction. Given the wide range of factors that will influence tax policy, it is important to consider the impact of any decision in a multitude of scenarios. If you would like to discuss your individual circumstances in greater detail, please contact us.
Disclaimer | Note: This article is for informational purposes only and does not constitute legal advice or tax advice. Please consult with your tax advisor or your attorney.If you still have questions or concerns regarding this topic, reach out to our retirement plan team experts—we would be happy to help.