On October 26th, we held a webinar to discuss the 2020 election and what the results could mean for year-end tax planning. As we discussed during the webinar, year-end planning during an election year requires us to work within the boundaries of existing laws while also trying to determine what the future could hold.
With Election Day behind us, we have more clarity about what the next four years may hold and, in this short article, we discuss Biden’s tax proposals and three critical year-end planning opportunities.
Before we explore the key year-end planning opportunities for 2020, let’s review Biden’s proposals from a tax and financial planning perspective. Investors should remember that these items are simply proposals; the actual legislation could be significantly different by the time it’s finalized.
The degree to which the final legislation will differ from these proposals depends largely on the outcome of the runoff elections for Georgia’s two Senate seats. Republicans currently hold 50 seats in the Senate, while Democrats hold 48 (Independent Senators Bernie Sanders and Angus King both reliably vote with Democrats). If Democrats win both runoff elections, there would be a 50-50 split in the Senate with Kamala Harris serving as the tiebreaker vote, effectively giving Democrats control of the White House and both chambers of Congress.¹
On the contrary, if Republicans win one or both of Georgia’s runoff elections, it will mean a divided government until 2022: a Democrat president, Republican Senate, and Democrat House of Representatives. A divided government would mean more concessions from Democrats on the proposals that follow.
Biden has proposed a 28% cap on itemized deductions, which would limit the value of tax deductions for those in the top brackets. He has also proposed a Social Security (i.e., payroll) tax of 12.4% on wages above $400,000. This would create a “donut hole,”² as these taxes currently exist on wages up to $137,700; in addition, both the employee and employer portion would be assessed. Finally, rather than waiting until current tax laws expire in 2025, he has proposed an accelerated timeline for returning to the top tax rate of 39.6% existing prior to Trump’s tax cuts.
Capital Gains Tax
For capital gains, the changes proposed by the incoming Biden administration are much more dramatic. He has proposed eliminating the preferential capital gains tax rate (which currently is a maximum of 20%) and instead taxing long-term capital gains at the ordinary income tax rate. For those with earnings over $1 million, this would effectively double the tax rate from 20% to 39.6%.³
Finally, Biden has also proposed significant changes to estate tax rates. Under current law, the estate and gift tax exemption is $11.58 million; under his proposed tax plan, the exemption would be lowered to $5 million, possibly on an inflation-adjusted basis.
More important for estate tax planners is the future of the basis adjustment — wherein the cost basis of assets transferred at death receive a “step-up” in basis to the current fair market value for assets that have appreciated⁴ — which Biden has proposed eliminating. If his proposal takes effect, it would drastically change the estate planning landscape, as many commonly-used estate planning techniques rely on maximizing the basis step-up.
Clearly, there are a number of moving pieces to these legislative proposals and your year-end planning for 2020. The following steps are the most critical for our clients; if you would like a personalized consultation on any of these points, we encourage you to get in touch with our team.
#1: If you are employed, revisit your 401(k) plan
If you’re still working, now is a good time to review your company’s 401(k) plan. In recent years, many employer-sponsored 401(k) plans have been modified to allow a Roth contribution option, which allows your full employee contribution to go into a Roth account, no matter your income level. Since 401(k) plans have higher contribution limits, this gives you an opportunity to accumulate more savings in a tax-free account — without the tax burden that typically comes with converting a traditional IRA to a Roth account.
#2: Review your overall gains and losses and harvest as needed
2020 has been a volatile year for markets. Considering the changes to capital gains and income taxes that could be coming, it is even more important to review your 2020 capital gains and losses and harvest them accordingly. Make sure your accountant is apprised of any significant capital gains recognized in 2020 as well as any large distributions from private investments, as either could result in higher income recognition — and a higher tax burden — when it’s time to file your 2020 return.
#3: Think strategically about philanthropy
As you plan your philanthropic efforts for the end of the year as well as for the future, make sure to maximize gifting of appreciated stock, either through a donor-advised fund or with a direct transfer of stock to the charity of your choice.
For those who are especially charitably inclined, 2020 offers a unique opportunity. In most years, only cash donations of up to 60% of income can be deducted from your taxes; however, this year, deductions for cash donations are allowed up to your full income. This allows you to bring your income tax for 2020 to zero (before surtaxes like the Net Investment Income Tax⁵).
Keep in mind that this rule change is only for 2020, and it only applies to cash donations directly to charities. To maximize the tax benefits, you could use cash donations in conjunction with a donor-advised fund by contributing your first 30% of income in appreciated stock to a donor-advised fund and then making cash donations of the remainder the charity of your choosing.
We are here to help
This has been an exceptionally volatile and challenging year, especially where financial and tax planning are concerned. The team at RVP remains committed to safeguarding your wealth and your financial well-being. If you would like to discuss any of the information in this article or would like a personalized consultation, we invite you to connect with the team at RVP.
ABOUT THE AUTHOR: JEFFREY FOSSELMAN, CFP®, CPA/PFS, JD
As Senior Wealth Advisor for Relative Value Partners, Jeff provides comprehensive advisory services in estate planning, income tax planning, cash flows, asset allocation and other financial planning areas. With more than a decade of experience in the industry, Jeff is instrumental in delivering financial planning strategies and counsel to high-net-worth individuals.
Jeff is also an attorney and has provided basic legal services in the areas of business consultation, formation of legal entities and drafting of estate planning documents.
After graduating with a Bachelor of Science from the University of Illinois in 2000, Jeff continued his studies and earned his Juris Doctor from the University of Illinois College of Law in 2003, and a Master of Science in Taxation from DePaul University’s Charles H. Kellstadt Graduate School of Business in 2010. He is also a member of the American Institute of CPAs – Personal Financial Planning Section and holds a CPA license with a Personal Financial Specialist designation. Finally, Jeff also holds the Certified Financial Planner (CFP®) designation.
¹ NBC News, ‘We are stunned’: Two Georgia races will decide which party controls the Senate.
² ThinkAdvisor, Biden’s Plan Would Create Payroll Tax ‘Donut Hole’
³ Tax Foundation, Joe Biden’s 2020 Tax Plan.
⁴ Tax Foundation, The Trade-Offs of Repealing Step-Up In Basis.
⁵ IRS, Questions and Answers on the Net Investment Income Tax.
Information contained in this article is obtained from a variety of sources which are believed though not guaranteed to be accurate. Past performance does not indicate future performance. This article does not represent a specific investment recommendation.
No client or prospective client should assume that the above information serves as the receipt of, or a substitute for, personalized individual advice from Relative Value Partners, LLC which can only be provided through a formal advisory relationship. Clients of the firm who have specific questions should contact their Relative Value Partners counselor. All other inquiries, including a potential advisory relationship with Relative Value Partners, can be directed here.