As we enter the dog days of August, we remain in the midst of the COVID-19 pandemic and extremely unsettled political times. The pandemic has resulted in unprecedented spending deficits by both state and federal governments. The economic impact of the pandemic and the increasing probability of a political change will likely result in increased taxes for high income and high-net-worth taxpayers.
Democratic presidential candidate Joe Biden recently unveiled proposals to increase the payroll tax on incomes over $400,000 per year, increase the maximum individual tax rate to 39.6% and eliminate preferential treatment on long-term capital gains tax rates. California has a proposal for a progressive surcharge on seven figure income earners which could increase the tax rate in the highest income bracket from 13.3% to as high as 16.8%.
To prepare for the possibility of higher taxes in 2021 and beyond, we have several suggestions.
The Tax Cuts and Jobs Act (TCJA) brought major tax law changes in 2018. Income tax rates of 10%, 12%, 22%, 24%, 32% and 37% replaced rates of 10%, 15%, 25%, 28%, 33%, 35%, 27% and 39.6%. The potential return to the pre-TCJA rates makes tax bracket planning even more necessary for 2020. Each taxpayer’s planning opportunities will be based on their specific circumstances. First and foremost, it is important to know what bracket you are in now and what bracket you are projected to be in two or three years from now. The long-standing strategies of deferring income and/or accelerating deductions to lower taxes will continue to be effective for many taxpayers. However, accelerating income or deferring deductions may allow certain taxpayers to maximize the benefit of a lower tax bracket this year or minimize the impact of a higher bracket next year.
In addition, review the potential benefit of converting all or part of an IRA to a Roth IRA in 2020. Roth IRAs can grow and be distributed tax free to the taxpayer or beneficiaries.
Also consider maximizing the 2020 distributions from retirement accounts to take advantage of the benefits of a lower tax bracket. For example, you could take a distribution in 2020 despite potentially having required minimum distributions waived under the SECURE Act.
Owners of closely held businesses may benefit by accelerating income in 2020 at both the entity and personal level depending largely on the entity type.
2020 long-term capital gains and qualified dividends are taxed at 0%, 15% or 20% based on taxable incomes. Taxpayers should review harvesting long-term gains to lock in the current low rates which will potentially increase.
Federal estate taxes currently apply to the amount an estate’s value exceeds $11.58 million for a single person ($23.16 million for couples). These amounts are scheduled to sunset in 2026 and return to $5.2 million for a single person ($11.58 million for couples). Given the mounting pressure to increase taxes, these exclusion amounts could be lowered before they sunset.
With this in mind we would suggest a thorough review of your current estate and gifting plans. The pandemic’s impact may have lowered closely-held business values, as well as other investment and personal assets, creating gifting or family transfer opportunities. Also, high-net-worth individuals should examine the potential benefits of Grantor Retained Annuity Trusts (GRATS) and, if inclined, Charitable Gift Trust or other philanthropic vehicles.
The pandemic has prompted many people to shelter in place in states that may not be their legal domicile. Since many states resident rules specify if you have a permanent place of abode in their state and are physically present in that state for a certain number of days (generally 183 days), you will be considered domiciled in that state and taxed as if you were a resident. With four-plus months remaining in 2020, these rules may give some taxpayers an opportunity to avoid a potential state residence challenge or to make a legal domicile change. Keep a calendar of days spent in each of your residences and make sure your estate documents have been updated to reflect your state of intended legal domicile.
There is no crystal ball to tell us the outcome of the election, never mind the policy initiatives that the winner will succeed in implementing. However, a combination of the COVID-19 pandemic wreckage and the highly partisan TCJA puts tax policy change in the spotlight. As Republicans demonstrated in 2017, a 60-vote majority is no longer required to enact major changes and some Democrats are floating the idea of eliminating the filibuster entirely. Given the magnitude of the potential changes on the table, it is never too early to prepare.