The widely-differing tax platforms of this year’s presidential candidates are creating a high level of uncertainty about the nation’s tax policy following the November election.
Without a change in administration, the estate and tax planning landscape will likely offer few major changes for the next four years. If Democrats gain control of Congress and the Presidency, it is likely that we will see significant shifts in tax policy that could be retroactive to January 2021.
High-income individuals must be cognizant of Democratic candidates’ proposals which would affect how you are taxed, including those noted below, and should consider planning strategies you could implement yet this year to take advantage of current tax policies, exemptions and rates.
Income Tax Proposals
- Restore the 39.6% marginal income tax rate for taxable incomes over $400,000.
- Restore the “PEASE limitation” for adjusted gross incomes (AGI) over $400,000 which would reduce itemized deductions by 3% of taxable income above the $400,000 limit, with a maximum reduction to 80% of itemized deductions.
- Example: The itemized deductions that could be claimed by a couple with $450,000 in AGI would be reduced by $1,500 (3% of the $50,000 difference between their AGI and the $400,000 limit).
- Limit itemized deductions to a 28% tax benefit.
- Increase the maximum long-term capital gains rate, also applicable to most dividends, from the current 20% to 39.6% for those with income over $1M. (Adding the 3.8% tax on net investment income produces a 43.4% rate.)
Social Security Tax Proposals
- Expand the social security tax base. In addition to the 12.4% social security tax (split evenly by employee and employer) levied on wages up to $137,700, wages over $400,000 would also become subject to the tax.
Estate Tax Proposals
- Reduce the temporarily high federal estate, gift and generation-skipping transfer (GST) tax exemptions earlier than the December 31, 2025, date when they are scheduled to sunset under the 2017 Tax Cuts and Jobs Act (TCJA).
- The current $11.58M per individual ($23.16M per married couple) exemption could be rolled back to pre-TCJA levels ($5M or even $3.5M adjusted annually for inflation).
- Increase in the top estate and gift tax rate (currently 40%).
- Eliminate the rules that “step-up” the basis of assets passed at death. These rules prevent beneficiaries from realizing capital gains tax liability on property appreciation that occurred before they inherited the property. The rules were designed to avoid double taxation (paying both estate and capital gains taxes) on the same value.
- Example: Beneficiaries inherit business stock with a fair market value of $10M and the decedent’s tax basis in the stock is $1M. If they sell the stock shortly after death for $10M, the beneficiaries will have no realized capital gains income under the current rules. Without the step-up in basis rules, the recipients would realize $9M of capital gains (possibly taxed at the proposed 43.4% rate described above) separate from any estate tax that was paid.
2020 Year-End Planning Strategies for a Possible New Administration
If tax policy changes are coming, you have a window of opportunity to create some tax efficiency before the end of 2020. Creating this efficiency may involve large and impactful transactions so you will need thoughtful deliberation to decide if any of the planning strategies below are appropriate for you. While many of these strategies should not be implemented before the election, your planning should be completed before then to allow time for changes by year’s end.
Income Tax and Social Security Tax Planning
- Accelerate bonuses and exercise non-qualified stock options this year to capitalize on lower income tax rates and avoid possible social security tax on compensation over $400,000.
- Consider a Roth IRA conversion to recognize income at this year’s lower income tax rates.
- Defer business expenses to take advantage of higher income tax rates next year.
- Determine proper timing of itemized and charitable deductions.
- Possibly defer payment of property taxes until next year - The current $10,000 limitation on deductions for state and local taxes (SALT) may be repealed next year, plus tax rates could be higher.
- Possibly defer charitable deductions if higher tax rates are expected next year.
- Balance deferments against other tax considerations, such as the reintroduction of PEASE limitations which reduce itemized deductions, the 28% tax benefit limitation, and the ability in 2020 to deduct qualified charitable contributions up to 100% of your AGI.
- Consider selling appreciated long-term capital gain assets and deferring the sale of loss assets to take advantage of this year’s low capital gains rates.
Estate and Gift Tax Planning
- Consider making gifts this year to fully utilize remaining lifetime federal estate, gift and GST tax exemptions.
- Consider a Spousal Limited Access Trust (SLAT) which is established for children or other family members but permits limited distributions to the trust grantor’s spouse.
Think Now and Prepare to Act
There is no certainty that any of the tax proposals described above will be implemented next year. However, many experts believe we will see pressure to raise taxes to help pay for COVID-19 relief measures and new programs. Your Warner estate planning attorney can discuss these planning strategies and others to help you prepare.
