Tax Planning for Potential Legislation Changes

By Philip "Rusty" Ross, CPA, Senior Wealth Advisor

We are inching closer to the November 2020 elections. While the presidential election garners the spotlight, the makeup of Congress will also impact legislative changes. As of today, betting markets are forecasting a win by former Vice President Biden over President Trump¹, an almost evenly split Senate and a Democratic-controlled House of Representatives.²

Politics aside, there are several potential outcomes from the election that will impact future policy and legislation. In this piece, we will review a few planning opportunities to consider under the current tax law and potential adjustments to keep in mind based on the proposals laid out by the Biden campaign.

1. Roth conversions
   Recent changes implemented by the Setting Every Community Up for Retirement Enhancement (SECURE) Act now require non-spouse beneficiaries to distribute inherited retirement accounts over a 10-year period, rather than over their lifetimes.³ This could place certain heirs in higher tax brackets during peak earning years. To take advantage of the present low tax rates and hedge against higher rates in the future, you might consider converting some pre-tax retirement accounts to Roth IRAs. This locks in the current low tax rates and allows the capital to compound tax-deferred for 10 years, with a lump-sum, tax-free distribution in year 10.
   
   This planning opportunity is attractive regardless of the election outcome. Still, if Biden wins, the time to complete the conversion strategy will be compressed and conversions should be accelerated in 2020 and 2021. If Trump wins, you can spread conversions out through 2025.

2. Tax-gain harvesting
   Certain areas of the equity markets have done incredibly well over the last few years⁴, leaving significant unrealized gains in some accounts. If a taxpayer presently falls into and expects to remain in a high tax bracket, these gains can create friction in rebalancing a portfolio or raising cash.
   
   Biden has proposed an increase for the long-term capital gains and qualified dividends rate to 39.6% for individuals with annual income greater than $1 million.⁵ For individuals with significant investment income, it may make sense to lock in some gains using losses and the present favorable tax rate. This can also create additional opportunities for harvesting in the future as the basis is closer to the current price. Of course, you should closely consider your unique situation and long-term financial goals before making any changes.

3. Charitable giving
   Under the Tax Cuts and Jobs Act (TCJA), you can deduct charitable contributions up to 60% of adjusted gross income (AGI) for cash, and up to 30% of AGI for donor-advised funds (DAFs) with securities or cash to a private foundation.⁶ The Coronavirus Aid, Relief and Economic Security (CARES) Act temporarily increased the limit from 60% to 100% of AGI for cash contributions made to charitable organizations for 2020.⁷ You can also fund a DAF with highly appreciated stock to avoid capital gains and front-load charitable plans for the coming years. This deduction can help reduce the tax impact and accelerate income for tax purposes like Roth conversions, exercising stock awards or realizing short-term capital gains.
   
   Biden’s proposal would bring back itemized deduction limitations for taxpayers above the 28% bracket and phase out further above the $400,000 income level.⁸ Therefore, making contributions prior to potential tax law changes could produce aggregate tax savings. However, be cautious in using charitable contributions to offset long-term capital gains or qualified dividend income, as they are taxed at a preferential rate. Instead, consider offsetting ordinary income with charitable contributions.

4. Estate planning and gifting
   The TCJA doubled the lifetime estate tax exclusion through 2026, and taxpayers who have not used any lifetime exemption could gift up to $11.58 million out of their estate in 2020.⁹ This provides a great opportunity to shift capital to heirs or move outside of your estate using any number of estate planning vehicles like trusts, family limited partnerships or gifting directly to heirs.
   
   Biden’s tax plan includes the removal of the step-up in basis for property passed at death.⁸ Although unlikely, if this proposal is passed, retaining unnecessary assets inside of a taxable estate would no longer be beneficial. Moving appreciable assets out of the estate sooner would be advantageous.

5. Income shifting
   For self-employed individuals and those who have vested unexercised options from their company or access to deferred compensation programs, the current low tax rates provide a good opportunity to accelerate income. There will also be benefits to controlling your taxable income under the proposal laid out by Biden’s team.
   
   Biden has proposed phasing Social Security taxes back in for those earning above $400,000 annually. Essentially, this creates a “donut hole” for earners between $137,000 to $400,000 where Social Security taxes would disappear.
   
   To put this into perspective, a taxpayer would likely face a 24% federal tax rate increase on income above $400,000 versus current law.⁸ This does not account for any state tax impacts. Controlling your ordinary income under a potential Biden presidency could therefore be crucial. Accelerating income into 2020 and 2021 is likely to be attractive and attempting to limit taxable income below the $400,000 level is ideal.

Regardless of the election outcome, planning opportunities remain for the current favorable tax environment. Keep in mind your current situation and the goals you have for your family, career and financial future. By anticipating potential changes in leadership and legislation, you can optimize your financial plan for the tax environment ahead.

Sources:
1. Reuters (8/7/20) — Betting markets favor Biden over Trump, but odds narrow in U.S. race
2. Chicago Tribune (4/5/20) — 2020 House of Representatives election odds: Democrats favored to retain majority
3. MarketWatch (1/8/20) — The SECURE Act is changing retirement — here are the most important things to know
4. Yahoo! Finance (data as of 9/22/20) — S&P 500
5. Tax Foundation (7/31/19) — Unpacking Biden’s tax plan for capital gains
6. National Philanthropic Trust (12/18) — Donor-advised funds and tax law changes: Understanding how new tax law changes may impact your philanthropy
7. Tax Policy Institute (4/8/20) — How the CARES Act increases charitable deductions without helping non-profits very much
8. Tax Foundation (4/29/20) — Details and analysis of former Vice President Biden’s tax proposals
9. Tax Policy Institute (5/20) — Key elements of the U.S. tax system

The S&P 500® is widely regarded as the best single gauge of large-cap U.S. equities. There is over USD 9.9 trillion indexed or benchmarked to the index, with indexed assets comprising approximately USD 3.4 trillion of this total. The index includes 500 leading companies and covers approximately 80% of available market capitalization.

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