2020 Election Season Tax Planning

2020 Election Season Tax Planning

Election Day 2020 is quickly approaching – setting the stage for possible tax rate changes based on the outcome.

While we can’t predict election results, we can offer tax planning strategies for the remainder of 2020 for both businesses and individuals.

2017 Tax Changes
To understand the current tax rates, we must go back to 2017 and the Tax Cuts and Jobs Act (TCJA) that President Trump signed into law on December 22, 2017. The TCJA was the first major overhaul of the U.S. tax code since 1986 and reduced tax rates for individuals, businesses and estates. Corporate tax rates were lowered from 35% to 21% and the top individual tax rate dropped from 39.6% to 37%.

At the time, Republicans were in control of Congress. That changed in the 2018 mid-term elections, with control switching to the Democratic Party.

In 2020, Democratic presidential candidate Joe Biden is proposing significant changes to the tax code, should he win the election. It’s important to note that a divided government makes tax changes difficult, so a Republican controlled Senate could block proposed changes by a Democratic president.

Biden’s Tax Plan for Individuals
Individuals with income over $400,000 would feel the greatest impact from Democratic tax plan. For those earners, the top individual tax rate could revert back to the pre-TCJA rate of 39.6%. Wages above $400,000 could also be hit with an additional Social Security tax. Currently, Social Security payroll taxes are capped at wages of $137,700. The proposed tax creates a 12.4% tax evenly split between employees and employers for wages over $400,000 – creating a “donut hole” where wages between $137,000 and $400,000 would not be taxed at this new rate.

Itemized deductions for this group would be limited to 28% of income and capital gains rates would increase from 20% to 39.6%.

The individual tax incentives woven into the Biden plan include student loan forgiveness, renewable energy-related tax credits and the reestablishment of the First-Time Homebuyers’ Tax Credit, providing up to $15,000 for first-time homebuyers.

The Child and Dependent Care Tax Credit (CDCTC) would expand from a maximum of $3,000 to $8,000 and the Child Care Credit (CTC) would increase from $2,000 to $3,000 for children 17 or younger, while providing a $600 bonus credit for children under 6.

Biden’s Tax Plan for Businesses
The Biden plan would see corporate tax rates increase from 21% to 28%. When corporate tax rates were lowered in 2017, the loss in federal revenue was offset with a number of corporate revenue raisers, including the repeal of the domestic production deduction, use of net operating losses (NOLs), limitations on business interest deductions and amortizing research and development expenses. Biden’s plan keeps all of the TCJA’s revenue raisers in place.

An overwhelming majority of U.S. businesses are not C-corporations but pass-through entities in which income is passed-through to the owners and taxed at individual rates. This means that 95% of businesses in America would be hit by the higher individual tax rates outlined in Biden’s proposal.

This group would also be impacted by a proposed phase out of 199A deductions if their income is over $400,000. Currently with the 199A deduction, the top effective rate on pass-through entities is 29.6%.

The Biden proposal also eliminates bonus depreciation and code section 1031, like-kind exchanges, which allow for a swap of one investment property for another making it possible to defer capital gains taxes.

There are some incentives for businesses in Biden’s plan, including expanding the New Markets Tax Credit and making it permanent, offering tax credits to small businesses that adopt workplace retirement savings accounts and expanding several renewable-energy-related tax credits.

Planning for Individuals
While we can’t predict the election outcome, certain things are within our control. For example, review your investments and keep an eye on appreciated assets.

Consider accelerating bonus payments and deferred compensation to avoid new Social Security taxes and make charitable contributions now to maximize deductions.

Planning for Businesses
Now is a good time for an analysis of entity choice. With a potential tax rate increase, limit on interest deductions and 199A deduction phase-out, the 4th quarter of 2020 provides an opportunity to consider whether your business should be set up as a C-corp or a pass-through entity.

Consider timing when it comes to bonus depreciation and choice of accounting method. Timing of revenue and expense recognition is the main difference between accrual and cash basis accounting. The accrual method recognizes income and expenses as earned and incurred. Cash basis recognizes earnings as cash is received and expenses when actually paid.

Planning: Final Thoughts
If there is a split Congress, expect limited tax changes in the near future. However, If Democrats control both the White House and Congress, tax changes could happen quickly.

For the remainder of 2020, it’s important to focus on more than just tax rates and begin developing a strategy while there is still time to act. When doing any tax or business strategy planning, we recommend working with your team of advisors.

For a detailed review of tax proposals refer to our previous post: Tax Proposals of the Presidential Candidates – Highlights and Summary.

For additional information or to reach out to a Herbein advisor, contact us at Article contributed by Thomas L. Bakaitus, Jr.