Reading The Tea Leaves of TaxationShare this post
By: Anthony J. Madonia
Over the past few weeks, I have watched several webinars, and read countless articles, on what may or may not happen to tax rates and deductions in the near future. At first, there was great debate about the presidential election. Now that Joe Biden will be our president, there has been much speculation on how our federal taxes will change.
As everyone knows, the federal government has spent several trillion dollars on various stimulus packages aimed at coping with the coronavirus pandemic. The federal government made several moves early on to keep the economy energized, in the hope that this pandemic would be short-lived. Now that we are into our 8th month, it is obvious to everyone that this pandemic will be here for a while. The most recent estimate I have seen for the widespread distribution of a vaccine is April of next year.
The remaining wild card of taxation is the Georgia runoff elections for the US Senate. That occurs on January 5th, 2021. In Georgia, a candidate must win by more than 50% of the vote. Since that did not occur, there is a runoff election between the top two vote-getters. Both of the Georgia Senate seats are up for election in January. Right now, the Republicans control 50 seats in the US Senate, and the Democrats control 48 seats. If both the Democratic candidates prevail, then each party would control half of the seats, and the deciding vote would go to the vice president, Kamala Harris. There has already been much debate, and hundreds of millions of dollars committed, to this runoff election. I don’t have any insight into this, other than to say that, if the Republicans win at least one of those Senate seats, it will have a dramatic effect on your tax bill going forward.
Much of what I have seen recently has focused on doomsday scenarios for how the tax code might change. I have heard the following paradigms suggested:
- A change in the estate tax which presumes that all of the decedent’s assets are sold on their date of death so that the capital gain on appreciated assets is reported on their final tax return.
- A declaration that inherited assets will be taxable income to the recipient.
- A loss of the “step-up in basis” for inherited assets, whereby the recipient of inherited assets would no longer use the date of death value of the decedent to calculate the gain on the sale of that asset. Instead, the recipient would use the decedent’s original cost basis.
- A reduction in the federal estate tax exemption to 3.5 million dollars, with a gift tax exemption of $1,000,000.
I think that the first 3 ideas listed are totally outside the norm of how taxes have evolved and would be surprised to learn that any of these are enacted. The 4th item listed, a reduction in the estate exemption and gift exemption, has a much higher chance of becoming law, in my opinion. I have also seen various proposals that are much more likely to be enacted, regardless of the votes tallied on January 5th. These proposals include:
- A repeal of the Tax Cuts and Jobs Act of 2017
- Additional payroll taxes on high income earners
- An increase in the marginal tax rate imposed on high income in individuals
- An increase in the corporate income tax rate
Before I discuss any of those proposals, it is important to consider that, while the government has the power to enact taxes retroactively, it would be very unusual to change the tax code prior to January 1st, 2021. Also, please keep in mind that there have been no changes to the tax code yet and that everything in this article is simply my thoughts on where tax changes will be enacted. Again, none of the changes mentioned in this article have been passed into law. I present this information only to get people thinking about their own tax situation, and what moves they may want to make to improve their situation.
One change that I strongly believe will occur is an expansion of the Social Security tax. As of 2020, the federal government charges a Social Security tax on wages of up to $137,700. There is talk of keeping that in place while imposing Social Security taxes on wages of over $400,000 . That would leave a window of between $137,701 and $399,999, where wage earners would not pay Social Security tax. I’m sure there will be attribution rules associated with this so that individuals who have the option of paying themselves a salary from multiple companies will not be able to escape this tax. Also, it’s possible that income from S corporations, which is currently not subject to Social Security tax, may become subject to that tax. In my mind, this is an easy tax increase to administer, and some variation of this is likely to occur in our future.
I also believe that the top marginal tax rate of 39.6%, for those earning more than $400,000 annually, will be restored, and that it may even go slightly higher than that. Given the current need for revenue, this is also an easy change to make.
There have been discussions about enacting a ceiling on itemized deductions of 28% of adjusted gross income for those earning more than $400,000 annually. The net effect of this is that any itemized deductions which exceed 28% of gross income would be disallowed.
Finally, there is talk of a phaseout of the section 199A deduction for those with taxable income above $400,000. This is a deduction which allows taxpayers with passive income from S corporations or LLC’s to deduct 20% of that income from the taxpayer’s gross income. This was enacted to level the playing field between pass-through entities and corporations since the corporate tax rate was reduced under the Tax Cuts and Jobs Act.
President-elect Biden has discussed assessing the ordinary income tax rate to long term capital gains for those with total income above $1,000,000, and also taxing qualified dividends at the ordinary income tax rate of 39.6% on income over $1,000,000. I think some form of these changes is likely to be enacted.
Given all these possibilities, I believe that these are strategies that can be implemented between now and December 31, 2020. Again, I have no way of knowing what changes, if any, will be made to the tax code. These ideas are strictly opinion, with no basis in fact:
- For taxpayers who have the flexibility to shift income from year to year, this may be the year to accelerate income into 2020, rather than defer it into 2021. Usually, planners are talking about deferring income at year-end – this year is much different.
- For taxpayers that have not used their full estate and gift tax exemption of $11,580,000, I suggest gifting prior to year-end to use up that exemption. I think there is a high probability that this exemption will be lowered.
- For taxpayers with built-in long term capital gains, this may be the year to harvest those gains at the 20% long term capital gain rate. Again, rates may be higher next year.
As we all know, each person’s tax situation is different. I welcome the opportunity to meet with you, either in person or virtually, and discuss ways to improve your tax situation for 2021 and beyond. Please, contact us with any questions you may have.