The policies of the two leading candidates facing off for president on Nov. 3 are dramatically different. Depending on whether Donald Trump or Joe Biden prevails, the way that families and individuals with wealth or significant earnings are taxed could take different paths beginning in 2021.
Our job is to prepare and educate clients about what may be coming, arm them with good questions to ask and point out what we believe will be optimal courses of action to explore.
THE BIG TAKEAWAY: START PLANNING NOW
If Trump wins, we can expect the tax code and rates to remain largely unchanged, at least through 2025, when many of the policies included in the 2017 Tax Cuts and Jobs Act will expire. We will focus on what we think could be the most significant income tax changes in the event Biden wins the presidency, and look at how those policies could translate into actions clients may want to take before Dec. 31, or before the tax deadline in the fall of 2021.
In the event of a Biden victory, tax planners and financial advisers will be swamped with requests for advice and action. It just makes sense, then, to think through some likely scenarios and draw up contingency plans.
A REAL-LIFE EXAMPLE: FICA TAX EXPANSION
Here’s just one case where policies suggested by the Biden camp could have an immediate impact: Currently, the Social Security portion of FICA taxes is set at a rate of 12.4% (with 6.2% paid by the employee and 6.2% paid by the employer) on the first $137,700 of compensation –- any earnings above that aren’t taxed for Social Security purposes.
Biden’s platform states that taxes will not be raised on taxpayers with income under $400,000. His proposal would reintroduce the Social Security wage tax on earnings in excess of $400,000, in addition to taxing the initial income. So taxpayers would pay their share (6.2%) of the Social Security tax on the first $137,700 they earn, and also be taxed the same rate on everything they earn above $400,000.
If you do the math on hypothetical compensation of $1 million, the difference in taxes is significant: Earning $1 million in 2020 will cost you $17,074 in Social Security taxes, while earning $1 million under the Biden proposal in 2021 would cost $101,474 (the $17,074 from the first $137,700, plus $74,400 on the last $600,000, which is the compensation above the cap).
So if Biden wins the presidency and Democrats take control of the Senate in November, anticipating that this new rule would have a good chance of being instituted, we would encourage clients to accelerate any meaningful compensation they can into 2020 — stock options, deferred compensation plans, bonuses and the like, which we normally look for ways to defer. Similarly, self-employed individuals would look to defer rather than accelerate expenses.
Any compensatory income that can be recognized in 2020 likely will be taxed less than compensation that is recognized later. But if the outcome of the election makes this change probable, clients won’t be alone in trying to make these moves in the final weeks of 2020, which is why it’s good to start planning now. After all, the FICA changes are just one piece of the puzzle., and you’ll want to consider the effects of a range of new and expiring tax rules, which we will discuss shortly.
This example highlights two of the main themes that we will need to apply to all the possible changes discussed in this article:
- Timing. When the rules are put in place, and when changes need to be made, varies from case to case. Some could take effect in 2021, and changes need to be made before Dec. 31 to secure the optimal outcome. Others might take effect in 2021, but you would have until the tax filing deadline in October to make adjustments. Many provisions will likely be debated and passed into law later, affecting future years but not the year to come.
- Compensation vs. investments. The FICA example affects compensation but not income from investments, and certain carried interests, which are taxed differently. When you think about your income, sourcing will affect what changes are in store and when you need to act.
INCOME TAX CHANGES
The most immediate impact might be seen in the rates at which income is taxed. As mentioned above, the addition of Social Security taxes on compensation over $400,000 is of immediate interest, since the window to recognize compensation before those rules go into effect could close at the end of this year.
The possible changes to how income is taxed are much broader than just FICA, however. The most significant could include:
- Increasing the top tax rate to 39.6% from 37% (affecting compensation earnings).
- Increasing the capital gain rate to 39.6% from 20% on income over $1 million (affecting earnings from investments).
- Capping itemized deductions at a 28% tax benefit.
- Increasing the corporate tax rate from 21% to 28%.
- Removing the state and local tax, or SALT, deduction cap (a change that would actually be taxpayer-favorable, particularly in states with high income taxes).
- Reinstating the Pease adjustment, which subtracts 3% from some itemized deductions if adjusted gross income is above a certain threshold.
- Changing or eliminating the 20% Qualified Business Income deduction.
There are a number of other possible rules changes on the table as well, with smaller but still significant impacts on the overall tax situation for family offices and highly compensated individuals.
In addition to considering future changes, taxpayers also need to make sure they don’t miss out on current benefits that are expiring. Most notable of these are some special CARES Act provisions that only apply for a limited time. These laws were passed to offer flexibility to businesses impacted by COVID and the economic slowdown that accompanied it in hopes of helping those businesses recover faster and help regenerate business activity. The most significant provisions in our eyes are:
- For the tax years 2018 to 2020, business losses can exceed the $500,000 annual limit that normally applies
- Net operating losses (NOLs) from 2018-2020 can be carried back five years, rather than just forward
The CARES Act also changes some of the rules around charitable giving, which may factor into your annual tax planning, especially a provision that allows charitable donations up to 100% of your annual gross income; more on this later.
So how does it all add up? Essentially, tax rates are more advantageous now for realizing compensation and capital gains than they likely would be after a hypothetical “blue wave” election. Simultaneously, a higher future tax rate means write-offs will be worth more in the future than they are today. And CARES Act provisions offer a unique one-time opportunity to make use of old business losses or maximize charitable gifts.
There are obviously a lot of moving parts to this scenario and some of the decisions that make sense in this case are counterintuitive to the choices normally made, which is why planning now is so critical. The timing involved is tight in some cases. Before the end of the year, you will want to consider:
- Accelerating compensation recognition into 2020.
- Deferring loss harvesting.
- Converting individual retirement accounts to Roths.
- Make major charitable gifts, perhaps through direct IRA contributions.
Other decisions, like the carryback and carry-forward of losses (and in some cases installment sale treatment), can wait until the filing of 2020 taxes later next year; for decisions that can wait, this will also give families a chance to see how aggressively and quickly tax reform is considered.
Mark Rubin is head of tax at Geller Advisors. Allen Injijian is the firm’s head of wealth strategy.
As our second lead editor, Cindy Hamilton covers health, fitness and other wellness topics. She is also instrumental in making sure the content on the site is clear and accurate for our readers. Cindy received a BA and an MA from NYU.