Now that Joe Biden is the projected winner of the 2020 presidential election, taxpayers may wonder how the shift in power from President Trump to President-elect Biden may impact tax policy. In December 2017, the Tax Cuts and Jobs Act (TCJA) was signed into law, representing the most significant tax code overhaul in three decades. The TCJA reduced tax rates for individuals and businesses and reduced the number of estates subject to the U.S. federal estate tax. The majority of the TCJA’s changes, except the reduction to the corporate tax rate, sunset at the end of 2025. Absent additional legislation, many of these changes will revert to pre-2018 tax law in 2026.
President-elect Biden previously stated he will seek action on his proposals to roll back many TCJA provisions, increasing taxes on corporations and individuals with incomes above $400,000. In order to pass tax reform legislation, there must be consensus between the White House and Congress. As a result of the November elections, the Democrats retained control of the House of Representatives, but at this point it is still too early to tell which party will control the Senate. After last week’s elections, so far the tally for the next Senate is 48 Republicans and 48 Democrats. Two seats in Georgia will be decided through special “run-off” elections on January 5th, because neither leading candidate reached the 50% threshold necessary to win. Two Senate contests are too early to call, one in North Carolina and the other in Alaska, but a Republican candidate leads each of these contests and is expected to prevail. Republicans are working to retain their majority, but even if they secure the final two races where ballots are still being counted in North Carolina and Alaska, they will still fall short of the 51 seats needed. Georgia is centerstage in a political struggle to determine which party controls the Senate and the outcome is expected to impact new tax legislation that may be enacted, if any. Upon conclusion of the Georgia run-off elections conclude, we will circulate an updated article commenting on potential US federal income tax changes. Because the Senate will include 48-52 Republican senators, we expect implemented tax law changes to be tempered by Republican senators and certain Democratic senators. We are closely monitoring the situation. In the interim, for illustrative purposes only, we offer below some planning considerations, which are dependent on each taxpayer’s overall tax posture and the enactment of proposed changes. As such, please consult your tax advisor prior to acting on any planning considerations mentioned below.
Individual Income Tax Rates
- Current Law – Under the TCJA, there are seven tax brackets applicable to taxable income, ranging from 10% to 37%, applicable through 2025. After 2025, absent additional legislation, the income tax rates revert to those under pre-2018 tax law. Beginning in 2026, the statutory rates range from 10% to 39.6%.
- Biden Plan – Proposes to increase the top rate to 39.6%, the maximum individual tax rate prior to the TCJA. Under his proposed plan, no other marginal tax brackets would change.
- Planning Consideration: High income taxpayers that sole proprietorships, partnerships, or S corporations (i.e., flow through entities) may consider permissible tax accounting methods and elections to defer deductions to future years or accelerate income recognition into the 2020 tax year.
Long-term Capital Gains and Dividends
- Current Law – Top tax rate for long-term capital gains and dividends is 20%. An additional net investment income tax rate of 3.8% generally applies to taxpayers not filing a joint return earning over $200K and married taxpayers filing a joint return earning over $250k. Taxpayers in the 10% and 12% tax brackets pay 0%. Taxpayers in brackets between 12% and 37% pay 15%.
- Biden Plan – Would increase long-term capital gain and dividend rate to equal his proposed top ordinary income rate (39.6%) for taxpayers with over $1M income. For taxpayers with over $1.0M taxable income, the long-term capital gains tax rate could nearly double from 23.8% (20% capital gain rate + 3.8% net investment income tax rate) to 43.4% (39.6% capital gain rate + 3.8% net investment income tax rate).
- Planning Consideration: High income taxpayers may consider recognizing large built-in capital gains in 2020 and deferring built-in capital losses to future years.
- Current Law – Taxpayers may take eligible deductions against their income tax liability including the qualified business income (QBI) deduction which allows business owners to deduct 20% of qualified business income through 2025. The itemized deduction for state and local taxes is capped at $10K. These changes, absent any additional tax legislation, are set to expire at the end of 2025.
- Biden Plan – Proposes that itemized deductions be limited in two ways. First, Biden would institute an overall 28% cap on the rate against which one could take itemized deductions. So, for example, an individual in the 39.6% (newly restored) tax bracket would see a 28-cent deduction for every item itemized, rather than 39.6 cents without the cap. Additionally, Biden would reinstate the “Pease Limitation” which was suspended through 2025 under the TCJA, for those with income above $400K. The Pease Limitation effectively reduces the amount one can deduct above a certain threshold. For every dollar of income earned above the threshold, the Pease Limitation reduces the value of itemized deductions by three cents. In addition, the Biden plan aims to phase out the QBI deductions for those with over $400K in earnings as well as the special qualifying rules for real estate investors.
- Planning Consideration: High income taxpayers may consider accelerating to 2020 charitable contributions originally intended to be made in 2021 or beyond.
- Current Law – The 12.4% Social Security employer (6.2%) and employee (6.2%) combined payroll tax rate applies to earnings up to an annual maximum ($137,700 in 2020).
- Biden Plan – Earnings between $137,700 and $400,000 would be exempt, creating a “doughnut hole” of nontaxable wages. Earnings above $400,000 would become subject to the 12.4% tax.
- Planning Consideration: Employers may consider the timing of yearend bonuses and certain other forms of incentive compensation to the extent commercially feasible and permissible under the specific compensation arrangement / plan.
Overhaul of 401(k) Tax Breaks
- Current Law – Workers can contribute money to their accounts on a pre-tax basis, meaning they do not pay taxes on any income put into the plan. This enables tax-deferred growth on the investment until retirement and earnings are only taxed when the funds are withdrawn from the account at retirement age when the worker may be in a lower marginal income tax bracket. The higher a worker’s tax bracket, the greater the benefit from contributing the same amount of money. Assuming a contribution of $19,500 (the maximum amount allowable in 2020 for workers under 50), an individual in the 37% tax bracket will get a tax savings of $7,215, but for an individual in the 10% bracket, the same $19,500 contribution will receive only a $2,340 benefit.
- Biden Plan – Proposes to give all workers the same percentage tax credit based on how much they contribute. Plans and amounts are not detailed yet, but initial estimates put the tax credit at about 26% of a worker’s contribution.
- Planning Observation: Having a flat 26% tax credit on retirement plan contributions would make them more attractive for taxpayers in tax brackets below 26% and less attractive in tax brackets above 26%.
Child Tax Credit
- Current Law – Taxpayers may claim a $2,000 per child maximum tax credit for children under age 17. If the credit exceeds taxes owed, families may receive up to $1,400 per child as a refund. This legislation is set to expire at the end of 2025.
- Biden Plan – Proposes to increase the child tax credit to $3,000 per child for children aged 6 to 17 and $3,600 for children under 6 for 2021, and beyond, if economic conditions require.
Child and Dependent Care Tax Credit
- Current Law – Maximum amount of care expenses to which the credit can be applied is $3,000 for one dependent and $6,000 for more than one dependent. Up to a 35% credit may be claimed on these expenses. The credit is non-refundable (if a taxpayer’s tax liability is less than the amount of credit claimed, the excess amount is not receivable as a refund). The credit is set to expire at the end of 2025.
- Biden Plan – The limit for eligible expenses would increase from $3,000 to $8,000 ($16,000 for more than one dependent) and bump the 35% credit percentage to 50% as well as making the credit refundable.
Corporate Tax Rates
- Current Law – The TCJA of 2017 reduced the tax rate to a 21% flat rate for all C-corporations regardless of taxable income level.
- Biden Plan – In addition to increasing the corporate tax rate to a flat 28%, Biden would also require C-corporations with over $100 million annual book income to pay the greater of the “normal” corporate tax liability or a 15% minimum tax on “book” profits, which is reported annual income net of annual expenses. This tax would function as an alternative minimum tax, replacing one that was in effect until the TCJA.
- Planning Consideration: Profitable corporations may consider permissible tax accounting methods and elections to defer deductions to future years or accelerate income recognition into the 2020 tax year.
Global Intangible Low-Taxed Income (GILTI)
- Current Law – Global intangible low-taxed income, or GILTI, enacted as part of the TCJA, creates a new category of foreign income that gets added to corporate taxable income each year. GILTI is the income earned by foreign affiliates of U.S. companies from intangible assets such as patents, trademarks, and copyrights. The TCJA imposed a 10.5% minimum tax on GILTI.
- Biden Plan – Proposes that the minimum tax rate on GILTI would double to 21%. The GILTI tax (and related foreign tax credits) would be calculated on a country-by-country basis, rather than using a worldwide average.
- Planning Consideration: Taxpayers impacted by this proposed change should model the implications of the change, including pertinent exceptions from GILTI, and evaluate their corporate legal structures for efficiency.
ESTATE AND GIFT TAXATION
- Current Law – The 2020 estate and gift tax exemption per individual equals $11.58M. Assets that pass directly to heirs generally benefit from a step-up in basis to fair market value at the date of a decedent’s death or the alternate valuation date (6 months after the decedent’s death). If the heir sells an inherited asset contemporaneous to inheritance, he typically pays little to no capital gains taxes. The increased exemption amount for both estate and gift tax purposes reverts to the pre-TCJA amount of $5.0M after 2025.
- Biden Plan – Proposes to eliminate the stepped-up asset basis coincident with the date of a decedent’s death or alternate valuation date. Heirs would receive a “carryover” basis in inherited assets rather than a basis adjusted to fair market value. An heir selling an inherited asset would be taxed on the asset’s unrealized appreciation at transfer. The Biden Plan also proposes reducing the estate tax exemption to $3.5M and limiting the gift tax exemption to $1.0M. In addition, his proposal includes increasing the top estate tax rate to 45% compared to the 40% maximum rate in effect today.
- Planning Consideration: In light of the reversion to pre-TCJA estate and gift tax exemption amounts after 2025 and Biden’s proposed changes to the estate and gift tax exemptions, taxpayers potentially impacted by the estate and / or gift tax should consult their tax advisors to confirm their estate and gift tax planning is up-to-date. Specifically, there are actions that could be undertaken to the extent a taxpayer has not utilized her entire $11.58M gift tax exemption.
Proponents of President-elect Biden’s tax proposals emphasize his plans generally apply to affluent Americans and businesses that quickly rebounded from the coronavirus downturn and such taxpayers have the wherewithal to shoulder an increased tax burden without slowing or reversing economic growth. Opponents of President-elect Biden’s proposals raise the prospect of slower economic growth as a potential reason to forego or delay tax increases. Enacting tax legislation requires consensus between Congress and the White House. After the November elections, the Democrats have retained control of the House of Representatives, but it is too early to tell which party will control the Senate. If the Republicans maintain control of the Senate, it may prove challenging to enact significant tax legislation. While taxpayers should be aware of possible tax changes on the horizon, unless a taxpayer is impacted by the TCJA’s provisions sunsetting, taxpayers should keep in mind proposed legislation often evolves prior to enactment and at times is not enacted.