Both presidential candidates have discussed substantially different tax plans leading up to this year’s election. It is impossible to predict if or when changes could occur if Joe Biden wins and the Democrats win control over the Senate. Yet, some of the proposed tax law changes in Biden’s tax plan could have significant long-term effects on high-wealth families. Below is an overview of a few possible scenarios as well as some planning opportunities for consideration.
If President Trump is re-elected, the Tax Cuts and Jobs Act of 2017 (“TCJA”) is set to expire in 2026. Experts anticipate that President Trump’s primary focus from a tax perspective is to make the TCJA provisions permanent.
If Joe Biden is elected, change is expected in the following areas: health insurance, tax reform, and re-assessing government direction in COVID-19 recovery, infrastructure investments, and climate change. This article’s focus is tax reform.
Potential Income Tax Changes
- Increase corporate tax rates: Rates will increase from the current rate of 21% to 28%.
- Increase maximum income tax bracket rates: Maximum tax rates on ordinary income will increase from 37% to 39.6%, and tax rates on long-term capital gains will increase from 20% to 39.6% once income exceeds $1,000,000.
- Limit itemized deductions: For individuals in the top tax bracket, a deduction will be limited to a 28% benefit. In other words, income is taxed at 39.6% but deductions only save 28%. Further, once income exceeds $400,000, itemized deductions are gradually phased out at three cents on the dollar. For example, at an AGI of $700,000, a taxpayer would lose $9,000 of itemized deductions.
- Impose Social Security payroll tax on more earned income: A Social Security payroll tax of 6.2% will be imposed on all earned income above $400,000. Currently, this tax is only applicable to the first $137,700 of earned income.
Potential Estate Tax Changes
- Decrease the estate exemption amount: The 2020 estate tax exemption is $11.58 million per individual. If the estate exemption amount is decreased, more assets will be subject to the estate tax. For example, an $11 million estate with the current exemption would not pay estate tax. If the exemption dropped to $1 million, this same estate would pay an additional $4 million of estate tax at the current tax rate.
- Increase the estate tax rates: The current estate tax rate is 40%. Biden is anticipated to increase the estate tax rates, perhaps even returning to the maximum 55% rate of 20 years ago.
- Eliminate the step-up in basis at death: Currently, at death, the basis of a decedent’s assets receives a step-up or step-down and is reset at fair market value. Thus, the current law allows appreciated assets to be transferred without an inherent capital gains tax liability. If eliminated, the heir would instead inherit low-basis assets and recognize capital gains on all existing appreciation at the eventual time of sale.
If Joe Biden is elected, how quickly would any tax law changes be implemented?
The speed at which any changes are implemented depends on which party controls the Senate. No one can say with certainty when Biden, if elected, could finalize any tax law changes. To predict, we consider the below timelines of significant historical tax law changes:
- 1992 election – President Clinton’s tax law changes were finalized in August 1993: retroactive to Jan. 1, 1993.
- 2000 election – President Bush’s tax law changes were filed in May 2001: effective from that point forward.
- 2016 election – President Trump’s tax law changes were finalized in December 2017: effective Jan. 1, 2018.
Given these historical precedents and other significant agenda items, it seems unlikely that changes will be finalized before next summer at the earliest. Given the scope of changes anticipated, many experts agree, particularly with respect to potential income tax changes, it is unlikely the change would be retroactive.
What planning opportunities should you consider?
We recommend evaluating your personal situation to determine what planning opportunities exist for you specifically. Depending on your financial risk and goals, below are planning opportunities to consider:
Estate Tax Planning
- Maximize use of remaining lifetime exemption: Transfer assets during life up to $11,580,000 out of your estate, gift tax free. If the lifetime exemption is lowered before you have used the full amount currently available to you, then future gifts and estate transfers may incur a tax liability that could have been avoided if you took action now.
- Accelerate planned gifts: For any planned future gifts, consider accelerating them to 2020 to ensure they are sheltered by the lifetime exemption. Examples of this include pre-funding a life insurance trust to cover future premium payments rather than making annual gifts each year as needed or creating a trust now to fund specific bequests payable at death that would otherwise be subject to tax given a lower future lifetime exemption amount.
- Maximize use of remaining GST exemption: Evaluate gifts in trust to future generations to eliminate estate taxes for multiple generations. Determine if late generation skipping elections should be made for existing trusts.
Separate from the election, the current low-interest rate environment also provides attractive estate tax planning opportunities. Example strategies:
- Intra-family loans at low interest rates
- Installment sales to grantor trusts
- Grantor Retained Annuity Trust (“GRATs”)
- Accelerate future charitable gifts into 2020: Gifts made in 2020 fully offset income, dollar for dollar. In contrast, Biden is considering the possibility of capping the benefit of future charitable deductions to only a 28% tax benefit.
- Considering gifting more in 2020 (CARES Act): Based on the CARES Act, cash gifts made in 2020 to most public charities are fully deductible up to 100% of income for those who itemize. Regardless of potential tax law changes, these gifts are traditionally limited to only 60% of a taxpayer’s income.
In addition to planning for tax law changes, there are also charitable planning opportunities made more beneficial in our current low-interest rate environment. A Charitable Lead Trust (“CLT”) is a vehicle that creates an annual income stream for charity prior to transferring remaining assets at a future date to beneficiaries. In a low-rate environment, the amount transferred to remainder beneficiaries gift tax free is maximized allowing a family to meet philanthropic goals, while simultaneously maximizing their estate tax plan.
Regardless of the outcome of the election and any potential tax law changes, there are many planning opportunities to consider pre-election that can help you reach your long-term goals. As a reminder, many families will be implementing new planning strategies over the next few months, so we highly recommend starting the process now rather than waiting until after the election. Please reach out to your Tolleson Wealth Management advisor to discuss any of these planning opportunities.
*This is not a CPA firm.