Financial Planning for a Post-Election World
Comparing the most significant tax policies of Biden and Trump can help ensure financial success no matter the outcome of the November election.
Digital Exclusive - 2020
Election Day is less than two months away. With economic uncertainty top of mind for voters, tax policy will be a critical point of differentiation in the 2020 presidential race, with financial ramifications for both individuals and organizations. If Democratic presidential nominee Joe Biden wins, his administration is likely to try to roll back many of the 2017 tax cuts and increase capital gains and payroll taxes on top earners, while in his second term, President Donald Trump would likely seek to make the 2017 tax cuts permanent and reduce the long-term capital gains tax rates through indexing.
Of course, there’s no guarantee that any of these policy proposals will be adopted as they appear today—or at all—but experts agree that current tax rates for both individuals and corporations are historically low and many of those low rates are scheduled to sunset after 2025. Higher taxes appear inevitable with mounting fiscal pressure to pay for COVID-19 relief measures—currently totaling over $3 trillion.
Here’s how Biden’s tax policies differ from Trump’s and how to plan for the unknown:
The largest source of new revenue from Biden’s proposal is an increase to the corporate tax rate, bumping it from 21 percent to 28 percent. Biden’s plan would also raise an additional $470 billion from an increase in tax on foreign profits and create a new alternative minimum tax of 15 percent on global book income, while still allowing net operating losses and foreign tax credits, for corporations with over $100 million in book net income. Biden has also proposed doubling the tax rate on global intangible low-taxed income from 10.5 percent to 21 percent for companies operating in the U.S. and abroad. He plans to phase out the 20 percent pass-through deduction for income over $400,000.
Trump is campaigning on making certain expiring provisions of the Tax Cuts and Jobs Act (TCJA) of 2017 permanent, including the 20 percent tax deduction for pass-through entities.
Facing potentially rising tax rates and a new corporate alternative minimum tax, corporations could consider income acceleration techniques and capital improvement projects. Rising corporate rates will also prompt many organizations to revisit their business entity structure to determine whether a partnership or LLC would be more advantageous than a C corporation.
For most individuals, Biden’s most impactful proposed changes are to personal income tax rates, which would return the current 37 percent top rate to the pre-TCJA level of 39.6 percent for taxpayers with incomes above $400,000. Additionally, Biden would limit total itemized deductions so the reduction in tax liability per dollar of deduction does not exceed 28 percent, meaning taxpayers in tax brackets higher than 28 percent will face limited itemized deductions. Additionally, itemized deductions for those with income over $400,000 would be further limited by restoring the pre-2018 Pease Limitation. This would reduce itemized deductions by 3 percent of AGI over the threshold—up to 80 percent of itemized deductions.
Trump proposes a 10 percent tax cut for the middle class, which may include lowering the 22 percent marginal tax rate to 15 percent, which in 2020 applies to income over $40,125 for individuals and $80,250 for married couples filing jointly. He also proposes to permanently extend the current lower individual rates and the higher basic standard deduction enacted by the TCJA that are scheduled to expire after 2025.
A lower income tax rate environment is generally favorable for Roth IRA conversions to lock in lower tax rates on pre-tax retirement savings. Deduction deferrals and income acceleration strategies, such as capital gains harvesting, are sound recommendations in anticipation of rising tax rates. While uncertain at this point, if Biden restores the state and local tax deduction for amounts above the current $10,000 cap, itemizers should also plan to defer payments of these taxes until after the law change. However, the potential benefit of this SALT deduction deferral would be reduced by the 28 percent top rate benefit ceiling and the restoration of the Pease Limitation discussed above.
Investment Income and Capital Gains
Under Biden’s plan, the tax rate on long-term capital gains and dividends would increase from 20 percent to 39.6 percent for taxpayers with income above $1 million. This income would also continue to be subject to the 3.8 percent net investment income tax as enacted in the Affordable Care Act. This would have a significant impact for high-income investors as well as founders and entrepreneurs who may experience a liquidity event. Individuals with highly appreciated assets may consider hedging the tax rate by selling some of those assets now before any rate increase comes into effect. Biden also supports a financial transaction tax on trades of stocks, bonds, and other financial instruments but has not released further details.
Trump says that he’s “very seriously” considering a capital gains tax cut through indexing capital gains for inflation. He has also proposed a capital gains tax holiday that eliminates capital gains taxes for a yet-to-be-determined period.
Investors with incomes over $1 million should consider selling appreciated assets before the 20 percent preferential rate for long-term capital gains and qualified dividends is eliminated. Another effective capital gains tax mitigation strategy is gifting appreciated assets to utilize the current increased estate and gift tax exemption. Similarly, charitable contributions of appreciated assets to qualified charities, including donor-advised funds and private foundations, is an effective way to sidestep the capital gains tax on disposition.
Reinvesting realized capital gains into qualified opportunity zone funds is another strategy—with both benefits and risks. The benefits include the ability to defer a current capital gain to 2026, avoid 10 percent of that current capital gain if it is held for five years, and permanently avoid all future capital gains after the contribution if held for 10 years or more. The risk, however, is that the deferred capital gain is subject to whatever capital tax rate is in effect in 2026, which could be a substantially higher rate than today.
Biden seeks to eliminate the Social Security tax exemption for wages and self-employment earnings above $400,000. Therefore, wages and earnings between $137,700 and $400,000 would not be taxed, creating a donut-hole structure. Because the 12.4 percent Social Security tax is split evenly between the employer and the employee, this proposal would increase payroll taxes for both high-income wage earners and their employers.
Trump, facing an impasse on Capitol Hill over coronavirus relief, issued an executive directive on August 8 to delay the deadline to submit payroll taxes for millions of workers until the end of the year. He said he hopes Congress will forgive those tax debts, but absent legislation, those payments will still be required by the extended due date.
Should the Social Security tax be expanded, business owners could consider converting to an S corporation structure, as S corporation dividends are not subject to employment taxes. As for executive compensation, incentive stock options would likely become more popular because there is no Social Security tax on the option spread.
Estate and Gift Taxes
Biden’s proposals on estate taxes are his most dramatic. The current estate tax exemption threshold is $11.58 million per individual (indexed for inflation) with a top tax rate of 40 percent. This amount is scheduled to revert to the pre-TCJA indexed amount of approximately $5.8 million after 2025. The Biden-Sanders Unity Task Force has recommended returning the estate tax regime to the “historical norm,” which could mean restoring the exemption threshold to the 2009 level of $3.5 million per individual and an estate tax rate of 45 percent rate, or possibly even higher.
Trump’s plan would extend the higher estate and gift tax exemption enacted by the TCJA that is scheduled to expire after 2025.
The Department of the Treasury confirmed that the temporarily increased estate and gift tax exemption would not be clawed back for taxpayers who die after 2025, but the increased amount is a use-it-or-lose-it proposition. This encourages taxpayers to act now to take advantage of the current increased exemption before the law changes or reverts in 2026 as planned. For example, an individual with a 2020 exemption of $11.58 million who only utilizes $9 or $10 million of that exemption through 2025 will lose the unused exemption amount above the $9 or $10 million in 2026 when the law reverts to pre-TCJA law, or earlier if a new Biden lower exemption limit is passed. Assuming Trump’s plan is not enacted, taxpayers with more than the full $11.58 million exclusion amount should plan gifts of their full exclusion amount before the exclusion amount reverts to a lower threshold.
Another consideration: With either a capital gains tax on assets held upon death or upon the later sale of inherited assets by the heirs who obtained a carryover basis, Biden’s proposal would create significant practical problems in establishing the tax basis of long-held assets such as family businesses or farms, or investment assets for which the historical tax basis is no longer available. Taxpayers with significant appreciated assets should carefully consider and implement a wealth-transfer plan prior to enactment of any tax reform.
Real Estate Like-Kind Exchanges
The TCJA repealed like-kind exchange treatment (Internal Revenue Code Section 1031) for personal property. However, the new like-kind provision allows investors to defer tax on gains from sales of real property by rolling the sales proceeds over into a subsequent real property purchase. Biden’s plan would repeal like-kind exchange treatment for real property for taxpayers with income over $400,000.
Retroactive tax legislation is very possible and a repeal of like-kind exchange treatment could be effective as early as Jan. 1, 2021. Taxpayers with real estate contemplating a Section 1031 like-kind exchange should complete their transactions to defer their tax gains prior to the effective date of repeal.
The 2016 election showed us it’s impossible to predict an election’s results, and whether any of these proposals become law depends not just on the election’s outcome, but on which party controls Congress. But taxpayers, investors, and business leaders can take steps now to set themselves up for financial success no matter what November 3 brings.
Illinois CPA Society member Daniel F. Rahill, CPA, JD, LL.M., CGMA, is a managing director at Wintrust Wealth Services. He is also a former chair of the Illinois CPA Society Board of Directors.
This information may answer some questions, but is not intended to be a comprehensive analysis of the topic. In addition, such information should not be relied upon as the only source of information; professional tax and legal advice should always be obtained. Securities, insurance products, financial planning, and investment management services are offered through Wintrust Investments, LLC (Member FINRA/SIPC), founded in 1931. Trust and asset management services offered by The Chicago Trust Company, N.A. and Great Lakes Advisors, LLC, respectively. © 2020 Wintrust Wealth Management Investment products such as stocks, bonds, and mutual funds are: NOT FDIC INSURED | NOT BANK GUARANTEED | MAY LOSE VALUE | NOT A DEPOSIT | NOT INSURED BY ANY FEDERAL GOVERNMENT AGENCY