Planning Ahead – Part 2October 14, 2020 -
Categorized in: IAG News
Today’s blog is the second in a two-part series regarding how a potential Democratic sweep in the November elections could impact your financial plan. Please read last week’s blog regarding itemized deductions and capital gains taxes here.
Today we focus our attention on income taxes, Social Security payroll taxes, and estate taxes.
Income taxes potential impact: In 2017 Congress reduced federal income tax rates for individual and corporate taxpayers. Former Vice President Biden has proposed increasing the corporate tax rate from 21% to 28% and increasing the personal income tax rate for taxpayers making over $400,000 per year to 39.6%. Raising the corporate tax rate would reduce future corporate earnings which could provide a headwind for future stock price appreciation. Raising personal income tax rates could reduce future net income for taxpayers, making future income less attractive than current income.
Social Security taxes potential impact. Currently employees and employers both pay 6.20% in Social Security taxes on the first $137,700 an employee earns each year. Self-employed taxpayers pay the full 12.4%. Former Vice President Biden has proposed expanding the Social Security payroll tax so it is also applied to all earnings over $400,000. Combined with income tax increases, the highest federal income tax rate paid for self-employed taxpayers could be 39.6% in income taxes plus 12.4% in Social Security taxes plus 3.8% in Medicare taxes – for a tax rate of 55.8%. State income taxes would be added on top of this, so in Wisconsin the highest income tax rate would be 63.45%.
Actions to consider: It is possible that any tax increases signed into law in 2021 could be made retroactive to January 1, 2021. Therefore, if you may be impacted by the proposed higher personal income tax rates and Social Security tax expansion, you may wish to accelerate some income into 2020 to lock in current tax rates if possible. Additionally, if you are a small business owner, you may wish to begin evaluating strategies for additional tax deferral after the election results are known. If you are an employee, you may wish to ensure you can maximize your employer-provided benefits to minimize your taxable income in 2021. In general, these proposed tax increases could make realizing income in 2020 preferable to paying taxes in future years.
Estate tax exemption potential impact: Currently each taxpayer is permitted to claim an estate tax exemption of up to $11,580,000 (with proper planning a married couple has a $23,160,000 exemption). Estate taxes are only paid on the value of an estate that exceeds these exemptions. Former Vice President Biden has proposed reducing this exemption by 50%.
Estate tax “step up” potential impact: Currently people who inherit taxable (not retirement) assets such as a house or investments receive a “step up” in cost basis. This means that when an heir sells an inherited asset, the taxable gain is calculated on the increase in value since the deceased’s passing. Former Vice President Biden has proposed eliminating the step up in cost basis, leaving heirs to pay taxes on any gains since the deceased purchased an inherited asset.
Actions to consider: If your heirs will lose a step up in cost basis, you may wish to consider selling appreciated assets prior to your passing if you are in a lower tax bracket than your heirs. It may also be beneficial to sell (not gift) your home to your heirs prior to your passing if you qualify for the capital gains exclusion for the sale of a primary residence. If you are blessed to have an estate worth over $5 million, you may wish to work with your tax and estate planning professional to evaluate whether accelerating gifts to the next generation before year-end may be advisable.
As with any campaign proposals, these provisions could be abandoned or changed significantly in the coming months. We are simply highlighting planning opportunities that could present themselves before the end of this year or early next year. Please be sure to consult with your personal tax and legal professionals before making any tax- or estate-related decisions.
Quote of the week: Warren Buffett: “If you mix politics with your investment decisions, you’re making a big mistake.”