In October we examined how the outcome of November’s Presidential Election might impact future stock market returns in the United States. If you will recall from the article, stocks have performed slightly better under Democrat Presidents than under Republican Presidents historically. The same data revealed that investors’ returns were even better when they were invested during all Presidential administrations, regardless of political party.
Now that we know the outcome of the election, we can turn our attention to another important financial planning topic: taxes. With Joe Biden’s presumed victory in the election, we can expect tax reform to likely occur in the coming months. We also need to wait until January to see the results of two senate Races in Georgia. If the Senate does indeed swing to a Democrat majority, based on the platform that Joe Biden ran on leading up to the election, here are some likely scenarios for tax law changes coming soon.
Social Security (FICA) Tax
As things stand today Social Security taxes are levied at a rate of 12.4% (6.2% paid by the employee, and 6.2% paid by the employer) on the first $137,700 of employment income in 2020. That wage limit increases to $142,800 in 2021. Joe Biden repeatedly said during his campaign that his new tax proposals would target those earning more than $400,000. Based on those statements, we can presume that additional FICA taxes would likely apply on income amounts above $400,000, creating a donut hole effect similar to what we see with Medicare Part D prescription drug coverage.
Income Tax Changes
A likely change to income taxes is an Increase in the top tax rate to 39.6% from 37%. Joe Biden has also proposed increasing the capital gains rate to 39.6% from the current rate of 20%, but presumably that rate would apply to those with incomes of $1 million or higher.
Other changes that Joe Biden has discussed do not change tax rates directly but could significantly alter the tax landscape for some taxpayers. One suggested tax reform that President-elect Biden discussed during his campaign was removing the state and local tax deduction cap introduced in 2017. This would allow taxpayers in states with high local and state income taxes to deduct higher tax amounts from their Federal tax burden at the expense of taxpayers in lower state and local tax states, like much of the Midwest. Joe Biden has also hinted at capping itemized deductions for taxpayers at the 28% tax bracket level, even if taxpayers’ incomes place them in higher tax brackets.
Two changes that Joe Biden hinted at during his campaign could hurt American businesses and business owners if they are implemented. The first change would be to alter or eliminate the 20% qualified business income deduction that went into effect in 2017. President-elect Biden has also discussed increasing the corporate tax rate from 21% to 28%. Corporate tax rates were lowered in 2017 to make US businesses more competitive with their international competitors.
Gift & Estate Tax
There has been speculation about potential changes under a Biden administration relating to gift and estate taxation. One possible change that has received some attention is the elimination of the step-up in cost basis at death. Instead of receiving non-qualified assets tax-free as is the case today, beneficiaries may owe capital gains tax if step-up in cost basis were eliminated.
There is also speculation that estate tax exemption amounts could be lowered significantly in the future, resulting in increased estate tax revenues. The current estate tax exemption is $11.58 million, but the exemption was half of that as recently as 2017. Lowering the estate tax exemption would help the Federal Government increase tax revenues by exposing more estates to the estate tax.
What You Can Do Before 2021
While there is a great deal of uncertainty concerning the timing of new taxes and everything that could be included in any anticipated tax legislation, there are still some actions that you can take during the last few weeks of 2020 to improve your tax situation for the remainder of 2020 and beyond.
- Accelerate Income into 2020 – If it is possible, you may want to accelerate income into the 2020 tax year. Today’s tax rates are relatively low by historical standards, and very likely to increase in the future, possibly as early as 2021.
- Defer Tax Loss Harvesting Until 2021 – Tax loss harvesting opportunities are likely to still exist in 2021 and will be more valuable in 2021 if and when tax rates are anticipated to be higher.
- Convert Traditional IRAs to Roth IRAs in 2020 – Converting traditional IRAs to Roth IRAs involves paying income tax on the amount of traditional IRA converted to Roth IRA. As mentioned before, tax rates are anticipated to be higher in 2021 and beyond, so conversions in 2020 will likely be at lower tax rates than conversions occurring in the future.
- Make Roth Contributions in 2020 and Traditional Contributions in 2021 and Beyond – Traditional (pre-tax) IRA and 401(k) contributions are more valuable to taxpayers when tax rates are higher. Since income tax rates are likely to increase after 2020, pre-tax IRA and 401(k) contributions will provide you with higher tax savings in the future than they will today. This strategy could be extremely valuable to high-earning taxpayers who could be subject to both higher income tax rates and additional Social Security (FICA) taxes on incomes over $400,000, if Joe Biden’s tax proposals are implemented.
Other tax avoidance and tax reduction strategies may be available to you. Call the financial planners at Bollin Wealth Management at 419-878-3934 to schedule time to talk about the steps you can take to reduce your tax obligations for 2020 and beyond.