Financial Moves to Make Now in Preparation for a Biden Administration’s Tax Changes
The most frequent questions I ask clients are: 1. What new or unplanned expense needs do you have, 2. What new income do you have, and 3. What charitable deductions and other major deductions do you have for this year and what deductions do you anticipate making over the next several years? Expenses that result in withdrawals, income, and deductions are three of the biggest drivers of taxes. Knowing about them as soon as possible allows me to make adjustments as needed, potentially keeping taxes down.
The previous paragraph may sound out of place in an article about future taxes in a new administration, but by knowing a client’s tax circumstances, we can best take advantage of things as they actually are, right now. This is of critical importance as we know in 2020 what the tax laws are today. The future of tax law is largely speculative, complex, and let’s face it – unknown.
With that being said, Joe Biden has shared some details about the kind of legislative changes he would like to see. Here are a few of his proposals:
- Raise income taxes on those making over $400,000 a year. At 39.6%, this would result in a 2.6% tax increase.
- Apply Social Security tax to wage income over $400,000. Currently Social Security taxes only apply to the first $137,700 of income. Should this be enacted, taxpayers with income over $400,000 could see a 6.2% tax increase.
- Treat long term capital gain and qualified dividend income the same as ordinary income (such as from employment) for those making over $1 million a year. This could increase the top tax rate from 20% to 39.6%.
- Lower the estate tax threshold: estates larger than $5 million to be subject to estate tax (down from the current $11,580,000).
- Increase the top corporate tax bracket to 28% (up from the current 21%).
- Have estates pay the unrealized capital gains of the deceased taxpayer.
What moves are people making now? As no candidate has shared detailed specifics of their proposals, making big moves in expectation of tax code changes is difficult and perhaps dangerous. Additionally, the outcome of the election is uncertain. Perhaps the smartest move to make is not to make any sudden moves. Making big changes could cost you a lot of money in anticipation of a possible situation that may not come to fruition. While people are interested and passionate about their preferred candidates, there has been no big rush to make changes based on political calculations.
So Many Priorities, So Little Time. When it comes to making changes, presidents have many pledges, but only enough political capital and energy to make a few happen. If Biden is the winner, he will have his hands full just dealing with the coronavirus and getting the economy back on solid footing. After that, Biden is likely to work on strengthening provisions of Obamacare. Democrats are also keen to pass legislation to address the racial disparities that have been highlighted through the murder of George Floyd and the ensuing protests for reform.
With so many issues in play, we might not see any major changes to the tax code until the coronavirus crisis is behind us (perhaps in late 2021 or early 2022). By the summer of 2022 we will be heading into another election cycle at which point Democrats are likely to be cautious about passing new tax laws that may stoke the ire of voters.
Again, when you do not know what new obstacles you will encounter, the best course of action is often no action at all. With this in mind, we know the Trump tax cuts have an automatic expiration date of December 31, 2025 and we know that the debt and deficit are moving perilously higher. One could make the assumption that improving the government’s balance sheet is important and might involve tax increases and/or budget cuts.
What I Recommend to Clients. One of the most significant opportunities may lie in making Roth Conversions. With required minimum distributions being waived for 2020 and Tax Cuts and Jobs Act (TCJA) tax cuts having an automatic expiration date, this may be a unique opportunity to pay a lower tax rate on IRA withdrawals. Roth IRAs can be especially beneficial when a person has an expense spike and traditional IRA withdrawals would push one into a higher bracket.
This is also an important year to plan for charitable contributions. Charitable deductions done carefully can reduce taxes or add space for making Roth conversions. While the standard deduction was almost doubled after TCJA passage (and eliminated the ability to itemize for many) taxpayers should consider whether combining several years’ worth of gifting by utilizing a donor advised fund (DAF) makes sense. Additionally, gifts of appreciated stock may provide a double benefit: first by avoiding taxes on the embedded gains of the position and second through the deduction.
The treatment of capital gains and qualified dividends as ordinary income could lead to quite a shock for those with over $1 million a year in income. To mitigate this, taxpayers in this income category should be vigilant about finding tax loss harvesting opportunities to reduce taxable income and monitor income carefully. Those with significant capital gains often have the important advantage of being able to control when gains are experienced. By making careful choices about which assets are sold and when, taxpayers may be able to avoid this tax.
Lastly, business owners using a sole proprietor or LLC legal structure may want to consider switching to a S Corporation. This may allow the business owner more flexibility in terms of how much of their income is subject to Social Security taxation. While the IRS requires business owners to pay themselves a “reasonable” compensation, this strategy could still save thousands of dollar s in Social Security taxes.
While a new administration is likely to usher in many changes, especially when the incoming and outgoing Presidents are members of different parties, taxpayers should be careful about being too reactive. A Biden Administration will want the economy to be strong and is unlikely to pass major tax legislation that would sabotage economic growth and future election prospects. However, making a few careful moves in 2020 to take advantage of current laws and being prepared for changes a potential Biden administration may enact could help bring a measure of calm to taxpayers concerned about the potential future tax proposals.
As with any financial planning strategy, the above article is meant to be educational and should not be used as specific advice. Before making changes to your investment strategy, make sure to first consult with a tax or financial planner.
