Former Vice President and Democratic presidential nominee Joe Biden recently released his corporate and individual tax plan. Biden’s proposed plan aims to raise approximately $3.2 trillion in new and increased taxes over a 10-year period, with most of the burden falling on large corporations and high-net-worth individuals. While there are many uncertainties in the legislative path forward, it is important that taxpayers work with their advisors to examine their current tax situation and prepare for a range of planning scenarios through the end of 2020 and into 2021.
Biden’s Tax Proposal
Biden’s plan appears to be largely influenced by three primary factors. First, as a long-time deficit hawk, he seeks to address the significant increase in the deficit’s size over the past four years (which has been further exacerbated by the COVID-19 pandemic). Second, Biden hopes to roll back several tax cuts and rate reductions enacted under the 2017 Tax Cuts and Jobs Act (TCJA). Third, possibly to capture a greater percentage of voters on the far left, Biden seems to be open to tax ideas previously monopolized by far more progressive candidates. (He has, however, stopped short of endorsing some of the most extreme ideas, such as a wealth tax and a financial transaction tax.)
With those influences in mind, some of Biden’s key policy ideas include:
- Increase the corporate tax to 28% (up from 21% under TCJA, but lower than the 35% rate in effect prior to TCJA).
- Repeal the 20% pass-through deduction of qualified business income for taxpayers with over $400,000 in income. This deduction was enacted under TCJA and is currently set to expire in 2026.
- Impose a minimum book tax equal to 15% on global financial statement profits for companies with over $100 million in annual income that otherwise pay zero or negative federal income taxes for the year.
- Double the global intangible low tax income on certain unrepatriated low-tax earnings to 21%.
- Repeal like-kind exchange deferrals for real estate.
- Institute a 12.4% Social Security payroll tax, to be split between employers and employees, on income earned in excess of $400,000. (Wages between $137,000 – the current cap – and $400,000 are not taxed.)
- Raise the top tax bracket for individuals from 37% to 39.6% (the top rate prior to TCJA) for taxable income above $400,000. The top tax rate is currently set to revert to 39.6% in 2026 without legislative intervention.
- Eliminate a preferential capital gains rate on income above $1 million.
- Abolish the basis step-up at death for inherited assets.
- Restore the pre-TCJA limitation on itemized deductions for taxable income above $400,000.
- Return the gift and estate tax exemption and rate to their “historical norms.”
The odds that many of these ideas are enacted exactly as Biden has proposed them are low. Although Biden currently leads in the polls, this could easily change. There are also impediments that could alter or block Biden’s proposal even if he is elected president. To control Congress, Democrats need to both retain their majority in the House of Representatives and pick up at least three Senate seats. Even with those three seats, the Democrats will have no margin for error due to a 50-50 divide in the Senate (assuming both independent senators vote in line with Democrats) and will need to rely on a vice president tiebreaker vote. Additionally, some Democratic senators may not welcome the idea of instituting tax reform during an economic crisis and with the 2022 midterm elections just a short time away. Memories of the Tea Party movement that grew in response to the Obama administration’s tax hikes in 2009 may still be fresh in the minds of some. However, if 2020 turns out to be another “blue wave” year (like 2018) in which Democrats outperform in the elections and pick up more than three Senate seats, they will have a greater margin for error, and the question will quickly turn from “if” taxes will go up to “how much” they will rise.
It is also important to note that it is unclear when new tax policies could be enacted. If elected, a new administration will be inaugurated on January 20, 2021. Typically, tax legislation goes into effect the following tax year, thereby allowing taxpayers the opportunity to plan around future tax laws with better knowledge of how policy changes will affect their income and wealth. Unfortunately, due to the pandemic, the current planning situation is highly unpredictable. A new administration may try to apply new taxes retroactively to January 3, 2021 (the first day of the 117th Congress), even if they are drafted and approved later in the calendar year. This is not completely unprecedented. On rare occasions, retroactive taxes have been enacted and deemed constitutionally permissible. There are several limits on when tax rates may be raised retroactively (yet “new” taxes may never be created retroactively), though the nuance of these limits is beyond the scope of this article. It is far safer to plan around the assumption that if taxes go up, they will do so as of January 3, 2021.
Although every planning situation is different, if Biden is elected, some of the most important planning ideas to consider before year-end are as follows:
Use remaining estate tax and generation-skipping transfer (GST) tax exemptions
The current federal estate tax exemption amount ($11.58 million per person) is scheduled to sunset to its pre-TCJA amount (adjusted for inflation) in 2026. Biden’s proposal suggests returning this amount to its “historical norm.” What Biden means by historical norm in this context is unclear, but some tax experts believe he may aim to reduce the exemption amount to the $3.5 million exemption proposed by the Obama administration in 2014. The same may be true for the GST tax – an essential component in dynastic estate planning – which has an equivalent but separate exemption amount that Biden could also propose to reduce.
Taxpayers with adequate assets that wish to make direct gifts to their descendants or fund multigenerational trusts should be able to use their remaining exemptions easily. Before making these gifts, taxpayers may want to confirm that they have sufficient access to assets for their own lifetime spending needs and that they are funding the gift with the most advantageous assets.
Using up exemption is slightly more complicated for taxpayers who are not yet prepared to pass on assets to descendants in 2020. There are several tools planners can use to work around these concerns, including spousal lifetime access trusts (SLATs) for married couples and domestic asset protection trusts (DAPTs), which are available to nonmarried individuals but are more limited in application due to the fact that they must be governed by one of 19 states that permits their use.
Both SLATs and DAPTs allow donors to contribute funds to trusts that qualify as “completed gifts” and thus use some or all of a taxpayer’s remaining exemption; however, each of these trusts allow some level of family access, either through a spouse (via a SLAT) or possibly the donor him or herself (via a DAPT), should they require additional funds for future spending needs.
Convert an individual retirement account (IRA) to a Roth IRA
A Roth conversion is a way to convert funds from a traditional IRA to a Roth IRA. A Roth IRA is a powerful retirement savings tool that, like a traditional IRA, allows assets to grow tax free. Unlike distributions from traditional IRAs, however, those from Roth IRAs are not taxed. Additionally, Roth IRAs do not have required minimum distributions that slowly deplete the account once the taxpayer reaches a certain age. Although an account owner pays tax on the funds transferred in the year of the conversion, this may still be an attractive planning tool if the account owner believes he or she is subject to a lower tax rate now than will be the case in the future.
Recognize long-term capital gains
If Biden eliminates the preferential long-term capital gains rate on income above $1 million, it may be advantageous for some taxpayers to recognize capital gains now to ensure they are taxed at 20% rather than their much higher ordinary income tax rate. However, due to numerous factors involved in the evaluation process, this should be approached with careful consideration.
Make charitable contributions early
If the pre-TCJA limitation on itemized deductions for taxable income above $400,000 is reinstated, 2020 may be the last year to make large or unlimited charitable contributions. Taxpayers should evaluate planned giving over the next several years and consider making those gifts in 2020 to maximize the tax benefits of their philanthropic goals. If a taxpayer is unwilling to make a large gift directly to charities this year, he or she could instead establish a donor-advised fund or private foundation, which may permit the taxpayer to take a larger deduction for 2020 and distribute the funds to charities over time.
Time transactions appropriately
Corporations may wish to consider ways to accelerate income in advance of a possible corporate tax rate increase. Corporate sellers will have an incentive to close transactions before 2021 and may want to reconsider income deferral transactions. Corporations may want to consider paying dividends in 2020 rather than future years. Employers could also consider paying year-end bonuses to high-income employees in 2020 rather than waiting until after the new year.
Partnerships, sole proprietorships, S-corporations and real estate investment trusts that have taken advantage of the Section 199A 20% deductions should consider ways to take advantage of them while they are still available.
A Note on Timing
Perhaps the most important takeaway from this analysis is that it is impossible to predict November’s election outcome and what tax policies will look like in the coming years. However, it is also clear that major changes could occur as soon as next year, and it is important that taxpayers are prepared to address a variety of planning situations. In addition, if the 2021 election warrants year-end tax planning, there will be an overwhelming rush to plan, and attorneys and accountants will not be able to keep up with demand. The best approach is to begin working with advisors now to map out complete gifting and tax strategies under various election and legislative scenarios. This may involve drafting trusts that may sit idle until Election Day, or possibly forever, but it will afford the luxury of making strategic and thoughtful tax decisions without the added pressures that the end of the year may bring. A BBH wealth planner would be happy to speak with you about your options.