By Joseph Zappia, CIMA, CCO/Co-CIO
With the election behind us, we thought it would be helpful to alert you to some of the tax planning ideas we are currently considering for clients.
Normally, year-end tax planning is focused on tax-loss harvesting, income deferral, and year-end gifting strategies. However, this year may be different. The potential for higher tax rates in 2021 makes accelerating income into 2020 a viable tax planning strategy for some. In addition, with proposed changes to the estate tax lifetime gift exemption going down, gifting strategies are more important now than ever before.
Of course, the timing of any of the proposed tax changes described here is uncertain. Tax legislation enacted early in 2021 may very well be grandfathered back to a start date of January 1, 2021. Any legislation passed later in the year may not take effect until 2022. Despite this uncertainty, now is the time to consider strategies and steps that may be taken before year-end.
The Biden Tax Plan
There are several key tax law changes that President-elect Biden has proposed. While Biden has promised not to raise taxes for any taxpayer earning less than $400,000, his tax plan proposes the following changes for taxpayers earning above $400,000:
- Raise the personal income tax top marginal rate back up to 39.6%, from its current 37% rate
- Apply a Social Security payroll tax of 12.4% on income over $400,000
- Limit itemized deductions at 28% of value
- Phase out the 20% qualified business income deduction
- Limit like-kind exchanges by real estate investors (1031 exchanges)
- Provide a First-Time Homebuyer Credit of up to $15,000
Another feature of Biden’s tax plan is a flat retirement contribution credit, as determined by a specific percentage (currently anticipated to be 26%) of the contribution amount to replace deductions of those retirement account contributions. This would, in effect, lower the tax burden for taxpayers in tax brackets under the proposed set rate (incentivizing taxpayers in lower tax brackets to contribute to tax-deferred retirement accounts), while increasing it for taxpayers in brackets over the proposed rate. Taxpayers should consider accelerating income and deductions before any proposed tax changes would take effect, potentially as early as 2021. One income-accelerating idea is a Roth IRA conversion. Pair this with a deduction-accelerating strategy, such as bunching charitable contributions, and you can minimize the tax hit from the additional IRA income while maximizing tax savings from claiming deductions in 2020. Furthermore, IRA assets would now be tax-free for the designated beneficiary, reducing their future income tax burden upon inheriting the IRA. View our video on Roth IRA conversions >
Potential changes to taxation on capital gains and investment income
One other major change Biden has proposed is to tax long-term capital gains and qualified dividends at ordinary rates if a taxpayer’s income exceeds $1 million. The current maximum long-term capital gains rate is 20%, while the proposed new maximum ordinary rate is 39.6%.
Taxpayers with appreciated securities should consider realizing some of their gains this year. You may also want to consider deferring capital losses. Your tax or financial advisor can run a tax projection to analyze the actual tax outcome of any planning decision.
Changes that may impact Estate planning
We could be facing vastly different scenarios for estate planning in 2021 and beyond. Currently, we are enjoying a lifetime estate exclusion amount of $11,580,000 (or $23,160,000 for married couples, indexed for inflation) with an estate tax of 40% assessed on the excess. This is set to expire in 2025 upon the sunset of the Tax Cuts and Jobs Act (TCJA), and the amounts will revert to $5,000,000 (or $10,000,000 for married couples, again indexed for inflation) unless Congress votes to extend the provision.
A final key feature of the proposed tax plan would be a 50% reduction of the exclusion amount for estate and gift taxes, from $11.58 million to the pre-TCJA amount of $5.79 million. To be cautious, taxpayers might consider using as much of their exemption in 2020 in case Biden’s tax plan is approved. Other strategies that can be considered to deal with a smaller exemption in the long-term can potentially include the use of Grantor Retained Annuity Trusts (GRATs), Charitable Lead Annuity Trusts (CLATs), and sales to Intentionally Defective Grantor Trusts (IDGTs).
It’s possible that the present gift and estate tax environment that we now enjoy may be the most favorable we will see for years to come.
Proposed tax changes for business corporations and small businesses
In addition to the individual and estate tax changes, there may also be tax changes for corporations. The proposed changes under the Biden tax plan would increase the corporate tax rate from 21% to 28%. Therefore, it is important for owners of small businesses and corporations to consider accelerating income to 2020. Similarly, partners and shareholders in LLC’s, S-Corps and partnerships should consider year-end tax projections to decide if it makes sense to recognize income in 2020 as opposed to 2021.
The results of the election could have a major impact on taxes over the next few years. If the democrats were to gain control of the congress and the Presidency, a so-called “blue wave”, many of proposed tax law changes are likely to be passed. A more watered-down solution is likely if the Republicans remain in control of the Senate. As of this writing, control of the senate is still up in the air and will not be decided until after the first of the year.
Now is the time to work with a tax or financial advisor who can help you understand the latest tax laws and can apply them to your personal circumstances.
The information contained in this summary is for informational purposes only and any opinions expressed are current only as of the time made and are subject to change without notice. The information provided is not intended to be, and should not be construed as, investment, legal or tax advice. Any investment advice provided by LVW Advisors is client specific based on each clients’ risk tolerance and investment objectives. This commentary is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances.