After a very challenging year, many of us are anxious to see 2020 come to an end. Before it does, however, there are a number of tax planning items to consider.
Now that Joe Biden has been elected the next President, it’s time to take a closer look at his proposed tax plan. We have already seen a number of tax law changes in 2020, particularly with the passing of the CARES Act earlier this year. It appears certain that more changes are on the way as a result of the change in administration in the White House, although the details and mechanics are unclear at this point. It’s important to keep in mind that the implementation of many of these provisions might depend on the makeup of the Senate, which will be determined by the runoff election for the two Georgia Senate seats in early January.
In this article, we explore two major areas: charitable contributions and capital gains, and focus on planning opportunities. We also outline some other significant tax law changes proposed in President-Elect Biden’s plan that would affect HNW individual taxpayers.
Biden is proposing limitations on itemized deductions for HNW taxpayers, which presents a number of planning considerations for charitable donations. His plan restores the “phase-out” of overall itemized deductions for high-income taxpayers, which was eliminated as part of the Tax Cuts and Jobs Act of 2017 (TCJA). Biden’s proposal also prevents itemized deductions from causing the effective tax rate to drop below 28% for high-income taxpayers.
As such, many CPAs are advising clients to accelerate charitable donations in 2020 to take advantage of the favorable limits currently in place under the CARES Act. The CARES Act allows for deductions of cash charitable contributions up to 100% of adjusted gross income (AGI), an increase from 60% of AGI in prior years, as well as an “above-the-line” (before AGI) deduction of $300 for cash contributions.
Specifically, taxpayers should consider the following strategies:
- Utilize a donor-advised fund (DAF) for charitable giving. A DAF allows flexibility, because you can use the funds to plan future giving to organizations while taking a tax deduction in the year the contribution to the DAF is made.
- Gift appreciated securities to a qualified charity or donor-advised fund. Doing so avoids capital gains tax, and the fair-market-value of the shares is deductible as a charitable contribution.
- Sell depreciated securities and donate the proceeds to charity in order to take a capital loss in addition to a charitable deduction.
Massachusetts Residents: Starting in 2022, individual taxpayers may also deduct charitable deductions on their Massachusetts state tax return, whether or not they itemize deductions for federal tax purposes. This deduction had been suspended since 2001. Deductible charitable contributions will be prorated for part-year residents, as well as non-residents earning income in Massachusetts.
Biden’s plan provides for an increase in long-term capital gains (LTCG) tax rates for high-income taxpayers. In his proposal, the top marginal tax rate for individuals reverts to 39.6% (currently 37% under the TCJA) for those earning at least $400,000 per year. Long-term capital gains would be taxed at the 39.6% rate (i.e., as ordinary income) for individuals earning over $1 million per year. There would be no change in LTCG rates for those making under $1 million. The Net Investment Income Tax (NIIT) of 3.8% would also remain in effect for individuals exceeding the NIIT income thresholds ($200,000 if single, $250,000 if married filing joint).
Specifically, taxpayers should consider the following planning opportunities:
- If considering selling appreciated securities for cash flow planning, accelerate these into 2020 instead of 2021 to take advantage of the current capital gains rates. The shares need to be held for at least 12 months to qualify.
- Loss “harvesting.” Consider selling depreciated securities before year-end to offset capital gains in 2020. Capital loss carryovers from prior years may also be used to offset realized capital gains.
- Consider gifting securities to a relative in a lower-income tax bracket, so they can take advantage of a lower tax rate when they sell the shares.
- Elect an installment sale, or spread sales of securities over multiple years, to minimize AGI and NIIT impact in a single year. This could also create a recurring cash inflow, which could be beneficial to cash flow planning.
Other Proposed Tax Changes under the Biden Administration
- State and Local Tax. Eliminate the $10,000 cap for the state and local tax itemized deduction.
- Payroll Taxes. Currently, Social Security tax is capped at $137,700 of wages. Biden’s plan proposes a “donut-hole,” where Social Security tax would kick back in at $400,000 of wages (i.e., this creates a “bubble” between $137,700 and $400,000 where wages are not subject to Social Security tax).
- Real Estate.
- Disallow like-kind exchanges on real estate.
- Increase the depreciation timeline for rental real estate.
- Estate Tax.
- Discontinue step-up in basis for inherited assets.
- Repeal the increased lifetime exemption. Currently under the TCJA, the lifetime exemption is $11.58 million per person as of 2020, and is scheduled to expire (i.e., revert back to $5 million) in 2026. Biden’s plan scales down the lifetime exemption to $3.5 million. It is likely this repeal would take place before 2026, but not be retroactive to 2020. Given this uncertainty, HNW individuals who are planning significant gifts might want to consider accelerating these into 2020 in order to take advantage of the current lifetime exemption.
As with any tax planning, it is imperative to work with qualified advisors to evaluate these matters, and make sure that your investment strategy and cash flow planning is not compromised. Please contact me or a member of your JDJ team for assistance.