Last month, the Associated Press called the presidential election for former Vice President Joe Biden. The House of Representatives will remain under Democratic control, but control of the Senate is still uncertain until early January 2021.
Under a Biden administration, and if the Democrats assume control of both the House and the Senate, taxpayers are likely to see increases to the corporate tax rate and to the top tax rate for individuals. Despite the uncertainty of the outcome, significant tax policy changes are possible over the next few years, so it is important to understand both current tax law and changes that may be on the horizon under a Biden administration. We have put together a list of some of the significant changes that have been proposed by President-elect Biden so far and considerations for tax planning, where available, as we close out the year.
Please note that the proposed tax policy changes discussed below are “proposals” and that final tax bills (if enacted) may differ significantly from President-elect Biden’s proposals. There is also no guarantee that the following proposals will be enacted in 2021.
Individual Income Tax Rates
Under President-elect Biden’s plan, the top individual federal income tax rate of 39.6% on ordinary income and net short-term capital gains would likely be reinstated (pre-TCJA rate) – up from a top rate of 37%. Individuals who are in the top tax bracket may benefit from accelerating income recognition in 2020, if possible. A couple of examples are Roth conversions and requesting bonus payout in late-2020 rather than early-2021.
Capital Gains and Qualified Dividend Income
President-elect Biden has proposed raising the long-term capital gains rate, which also applies to qualified dividends, from 20% to 39.6% on income over $1 million. Therefore, individuals who are planning to sell in 2021 should perhaps consider doing so in 2020 instead. For future years, it may be beneficial to utilize installment sales when possible to avoid exceeding the $1 million threshold, if enacted.
Qualified Business Income Deduction
Under current tax law, many “pass-through” business owners (owners of partnerships, LLCs, S Corporations, and sole proprietors) qualify for a qualified business income deduction of up to 20%, which can lower the effective tax rate on the business income of individuals from a high of 37% to as low as 29.6% for qualified businesses. President-elect Biden would phase out the tax benefits associated with the qualified business income deduction for individuals making more than $400,000 a year, thus effectively raising the business income tax rate from 29.6% to 39.6% for some individuals.
The TCJA reduced the corporate income tax rate to a flat 21% from a progressive rate of up to 35% and eliminated the corporate alternative minimum tax. President-elect Biden has proposed raising the corporate tax rate from 21% to 28% and putting in place a new form of corporate alternative minimum tax. Corporations may benefit from accelerating income recognition and delaying deductions, where possible.
Under current law, a Social Security tax of 6.2% and Medicare tax of 1.45% are imposed on both the employer and the employee. While the wage base for the Medicare tax is unlimited, there is a ceiling on the Social Security tax base equal to the first $137,700 (for 2020) of employee wages. President-elect Biden has indicated he would remove the ceiling on the wage base for the Social Security tax for employees and self-employed individuals making in excess of $400,000.
President-elect Biden has proposed to reduce the current $11.58 million lifetime exclusion for Estate and Gift tax to $3.5 million and increase the top estate tax rate from 40% to 45%. A strategy to mitigate the impact of the potential reduction in the estate and gift tax exclusion would be to use as much of it as possible before the year-end.
Year-end tax planning is always challenging, but the coronavirus pandemic and uncertainty around how tax policies may shift add new layers of complexity to the equation. It is more important than ever to get a head start working with your tax professional on year-end tax planning. We urge you to obtain professional advice before acting on any of the suggestions provided in this article.
For more information on tax planning strategies, download our 2020 Year-end Year-round Tax Planner below.