By: William Lalor, CFP®, CFA
The 2020 election has proven to be one of the most contentious in recent history. Pair this with the fact that 2020 has been anything but ordinary and you have an election year truly like no other. In our Market Insights piece published on October 7th, our Head of Investment Research Wayne Yi considers the impact that the 2020 presidential election could have on financial markets. In this piece, it is my hope to explain what each candidate’s proposed tax plans would mean for Americans. Let’s look at some of the key differences between the tax plans being presented by the two candidates leading up to the 2020 election.
|Joe Biden’s Proposed Plan||Donald Trump's Proposed Plan|
Individual Tax Rates:
Biden seeks to restore the 39.6% top tax rate for those with taxable incomes above $400,000. Currently the top tax rate sits at 37%.
Trump would keep the top 37% tax rate as is. Additionally, he would implement a 10% rate cut for middle-income earners, effectively lowering the 22% rate to 15%.
Biden has proposed capping the tax benefit of itemized deductions at 28% for those with incomes above $400,000.
There is currently no cap on the tax benefit of itemized deductions, Trump’s tax plan does not seek to change this. The current $10,000 state and local tax (SALT) deduction cap would remain in place.
Capital Gains and Dividends:
Biden has proposed that long-term capital gains and qualified dividends be taxed at the top ordinary income tax rate for those with incomes above $1 million.
Although he has not offered any specifics, Trump has indicated he would reduce tax rates for capital gains.
Gift and Estate Tax:
Biden has proposed to restore the estate and gift tax rate and exemption to 2009 levels. This would reduce the current $11.6 million ($23.16 per couple) exemption down to the $3.5 million. It would also increase the gift and estate tax rate to 45%, up from the current 40% tax rate.
Biden has also proposed an elimination of the step-up in basis at death.
When the TCJA was implemented, the $5 million estate tax exemption was doubled to $10 million ($11.58 million for 2020). It is scheduled to revert to $5 million after 2025. Trump has stated that he will push to extend the more generous estate tax exemption and would not change the rules relating to a step-up in basis.
Corporate Tax Rates:
Under Joe Biden’s plan, he would raise the flat rate to 28% and reinstate the corporate AMT for companies with net earnings over $100 million.
The TCJA replaced the previously graduated corporate tax structure with a flat 21% rate and repealed the corporate alternative minimum tax (AMT). Trump wants to preserve the status quo and has no plans to reinstate a corporate AMT.
Biden has proposed implementing a 12.4% Social Security payroll tax on earned income above $400,000. This would be split between employers and employees.
A recent executive order under Trump postponed Social Security tax for employees from September 1st through the end of 2020. He has said that this reprieve could become permanent.
Financial Planning Considerations for a Changing Political Landscape
Planning for a Capital Gains Tax Increase
For investors with incomes greater than $1 million, the timing of the realization of capital gains and losses could be impactful. Investors impacted by an increase in the tax rate should consider the following:
- Realizing long-term capital gains before the end of this year to lock in the current preferential capital gain rate of 20%. This is especially important for investors with concentrated stock positions looking to diversify their investment holdings
- Reinvesting the proceeds from currently realized capital gains into an Opportunity Zone (OZ) fund before year end. The OZ fund is a great tool to both defer and reduce the impact of taxable capital gains over several years
- Gift appreciated stock held longer than one year to a Donor Advised Fund (DAF) for more effective charitable giving (discussed further below
- Defer selling securities with losses until next year. These losses could be more valuable when offsetting capital gains taxed at the proposed higher tax rate of 39.6%.
Charitable Planning with New Deduction
- For individuals subject to the highest tax brackets, consider making charitable gifts this year to maximize the current year tax benefit of these deductions.
- For individuals with a more substantial charitable giving intent, consider opening a Donor Advised Fund (DAF). DAFs are typically funded with long-term capital gain property (such as appreciated stocks), resulting in a tax deduction for the current market value of the property without having to report any capital gain upon disposition. An immediate tax deduction is generated when the property is contributed to the DAF. The donor then has the freedom to recommend grants from the DAF over time.
- Cash contributions became more attractive this year under the CARES Act. Individuals can elect to deduct cash contributions of up to 100% of their 2020 adjusted gross income, from a previous limit of 60%. This 100% limit only applies to cash contributions made directly to charitable organizations (and not to DAFs).
Review Your Estate Plan Now
With the real possibility of significant changes to current estate and tax laws on the horizon, now is an ideal time to thoroughly review and update your estate plan. Estate planning takes considerable time to craft highly customized strategies, draft legal documents and, if necessary, move and/or retitle assets. We encourage you to get started now to have an actionable plan heading into the end of the year.
Use Your Estate and Gift Tax Exemptions Sooner Rather Than Later
For married couples with a net worth more than the current Federal estate and gift tax exclusion amount of $23.16 million who are looking to gift in excess of $10 million from their estate, consider utilizing some or all of your remaining exemption amount in 2020. These higher exemption amounts were implemented as part of the Tax Cuts & Jobs Act of 2017. They are set to expire at the end of 2025 and revert back to $5 million. A change in the political landscape could see this exemption amount reduced sooner and lower than the $5 million limit.
Estate Planning Opportunities in a Low Interest Rate Environment
Interest rates are an integral part of many attractive estate planning strategies. Fortunately, the Internal Revenue Service provides interest rate guidelines - referred to as the Applicable Federal Rates (AFRs) - that serve as a safe harbor for many of the transactions used in estate tax planning. There are a number of strategies that successfully take advantage of the current low interest rate environment.
Sales to Intentionally Defective Irrevocable Trusts
A popular estate planning technique involves the sale of appreciating assets to a trust in exchange for a promissory note. This type of transaction allows an individual to “freeze” the value of assets “sold” to the trust for estate tax purposes, thereby removing the future appreciation of the assets sold from one’s taxable estate. Distributions from the trust are generally made each year to pay down principal and interest associated with the promissory note. The terms of the trust allow the individual to pay the trust’s income taxes further reducing one’s taxable estate, a core component and benefit to this type of transaction.
Intra-family loans are a simple and effective wealth transfer technique. A common example is a parent lending an adult child money to purchase a new home at the IRS’s below-market AFR interest rate. While the borrower is obligated to pay interest on the loan, the lender commonly utilizes the annual gift tax exclusion amount ($15,000 in 2020) to offset the interest due, with the remaining amount reducing the outstanding loan balance.
Grantor Retained Annuity Trust (GRATs)
Grantor retained annuity trusts (GRATs) are a great planning tool to transfer assets with little to no gift or estate tax consequences. This is also an effective technique for individuals who have already utilized their Federal estate and gift tax exemption. A trust is created when an individual (the grantor) contributes assets with high appreciation potential to an irrevocable trust for a fixed number of years. The grantor then receives an annuity stream calculated by using pre-determined AFR rates set by the IRS over the life of the trust. When the term of the trust ends, the remaining assets in the trust are then distributed to beneficiaries of the trust, normally the grantor's children.
Spousal Lifetime Access Trust (SLATs)
Spousal Lifetime Access Trusts have become an increasingly popular tool for married couples for multi-generational planning. If properly implemented, assets placed into SLATs are considered a completed gift for income tax purposes, but remain available, if necessary, to support the needs of the spouse and beneficiaries.
With the prospect of higher market volatility and higher ordinary income rates, a Roth IRA conversion is an attractive option for many investors these days.
A Roth conversion is the process of taking all or part of one’s traditional IRA account and converting it into a Roth IRA. The amount you convert is taxable in the year you complete the conversion, but the assets will then benefit from growing tax-free over your remaining lifetime. We often look for opportunities to implement this strategy during significant market corrections since the temporary drop in market value reduces the immediate tax liability associated with the conversion. Additionally, for investors who are subject to estate taxes, the income tax paid on the Roth conversion will further reduce the investor’s taxable estate. All future distributions from Roth IRAs are tax free.
We’re Here to Help
While not every strategy may fit your personal circumstances, this list is meant to cover at least something for everyone. We recommend not waiting until the election results are in to start having a conversation with your Client Advisor team. We are available to help you develop a customized plan to take advantage of these and any other opportunities that might arise. At Simon Quick, we have the knowledge and experience to help guide you through this process. Please call us at 973-525-1000 or email Info@simonquickadvisors.com to set up a consultation.
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