Tax Planning for the New Administration

Control of the U.S. Senate will not be determined until the Georgia run-off elections in January.  And yet, as we approach year-end, it is wise to consider the upcoming Biden administration’s proposed tax changes.

Gift and Estate Taxes: A person can pass to a non-spouse, by gift or his/her estate, $11.58 million tax-free. A surviving spouse can use the unused portion of the tax-free amount of the first spouse to die, enabling a couple to pass $23.16 million to children without a tax bite.  

This law sunsets in 2026 and the old rules come back into play, reducing the amount that can be gifted or inherited to about $6 million per spouse.  Under the old rules, the unused portion of the tax-free amount is not automatically portable to the surviving spouse. The real risk is the Biden-Harris campaign announcement that it would reduce the tax-free transfer amount to $3.5 million and raise the estate and gift tax rate from 40% to 45%.

Income and Capital Gains Taxes: Currently, the top income tax rate is 37%.  Taxpayers with adjusted gross income over $200,000 ($250,000 for couples) pay an additional 3.8% tax on net investment income.  And capital gains are now taxed at a maximum rate of 20%.  

For those with income over $1 million, Biden proposes to raise the top income rate to 39.6% and treat long-term capital gains/qualified dividends as ordinary income, effectively raising the rate to 43.4% (39.6% + 3.8%).

Limitation on Itemized Deductions: Biden proposes to limit itemized deductions for high earners (income greater than $400,000) to 28% of their value.

Loss of step-up in tax basis:  Presently, when a taxpayer dies owning a capital asset, his heirs get a fresh start in tax basis since the tax basis of a deceased owner “steps up” to fair market value at death.  This would go away with the Biden plan.

Social Security: The Social Security payroll tax is imposed on income up to $137,000. Biden intends to impose a 12.4% payroll tax on income above $400,000 with the curious result that incomes between those amounts would not be taxed.

Corporate Tax Rate and Qualified Business Income Deduction: Biden proposes raising the corporate tax rate from 21% to 28% and doing away with the Sec. 199A qualified business income deduction designed to put small business owners into a tax regime similar to C-corps.

Tax Steps to Consider Taking Now:  

• Without new legislation, a taxpayer could have waited until the end of 2025 to make large gifts to children to capture the gift/estate tax-free amount of $11.58 million.  However, what if a Biden administration with a Democratic Congress institutes a new law with only a $3.5 million tax-free amount? And what if the law is made retroactive to Jan.  1, 2021? Business owners should assess whether large gifts should be made in 2020.

• Currently, in addition to the gift tax-free amount, one can give an unlimited number of persons $15,000 annually. Such “annual-exclusion” gifts should be fully used in 2020.

• Large capital gains should be taken this year, not next.

• The current rules allow a taxpayer to pay for the medical care or tuition of another in an unlimited amount. Such expenses might be pre-paid this year.

If the Republicans hold the Senate, any tax changes are likely to be tempered, although I believe the existing Trump tax bill will sunset in 2026 in all events. If so, there will be time to employ a number of more complicated tax strategies before the existing law expires.  These will be discussed in future articles.

Legal Strategies is sponsored content produced by Johnson & Johnson Law Firm in Canfield.

Copyright 2021 The Business Journal, Youngstown, Ohio.