Depending on the outcome of the November 3 election, the U.S. could once again see tax reform. Like the Republicans did in 2017 with the passage of the Tax Cuts and Jobs Act (2017 Tax Act), a Democratic shift in the legislative and executive branches after the 2020 election could result in a similar overhaul. Below is a brief discussion of a selection of Joe Biden's noteworthy tax proposals and analysis of the steps taxpayers might consider taking in 2020 in anticipation of a tax overhaul in 2021. It should be noted that Biden has not released a formal tax plan as of the date of this alert's publication. Accordingly, the discussion below is subject to change as more information is released (it is hoped) in the coming months.
Increased Tax on High Earners
Increased taxes for high earners are a cornerstone of Biden's tax proposal. The highest income tax rate would be restored to 39.6% (the 2017 Tax Act reduced this rate to 37%, which is the current law). Long-term capital gains, currently taxed at a lower preferential rate of 20%, would be taxed at the ordinary 39.6% rate for individuals with income of more than $1 million. Accordingly, taxpayers who may be executing capital gain transactions in the near future should consider accelerating such transactions to close in 2020, thereby avoiding potentially much higher tax rates in 2021.1 Similarly, taxpayers who are considering a deferral of any advance payments of royalty or service income under the deferral method may consider accelerating recognition of such income.
Itemized deductions may become less attractive to high-income taxpayers. While the 2017 Tax Act significantly reduced the viability of itemized deductions, some taxpayers may still find such deductions economically feasible. Biden's tax plan would further hamstring such deductions. First, Biden has proposed a 28% cap on itemized deductions. Second, Biden intends to bring back the Pease limitation on itemized deductions. Before the Pease limitation was repealed by the 2017 Tax Act, taxpayers with adjusted gross income above a certain threshold saw their available itemized deductions reduced by 3% for every dollar that their adjusted gross income exceeded such income threshold. The 2017 Tax Act did away with the Pease limitation until 2026. Under Biden's tax plan, the limitation could return as early as 2021. The income threshold for the limitation would be $400,000.
Significantly, payroll taxes would be increased by 12.4% (half for employees and half for employers) for taxpayers who earn wages above $400,000. Taxpayers should reevaluate their equity compensation structures to explore mitigation of a potential increase in tax liability.
Finally, the QBI deduction would be phased out for taxpayers with income above $400,000.2 High-income taxpayers who have structures for QBI in place might consider whether such structures should be unwound.
Corporate Changes
Corporations, especially those with foreign operations, may feel the squeeze in a Biden presidency. The corporate tax rate will increase to 28% – up from the 21% instituted by the 2017 Tax Act, but still below the top corporate rate of 35% that existed before. A 10% offshoring surtax will also be imposed on the profits of any production by a U.S. company overseas for sale back to the U.S.; furthermore, there will be a 21% minimum tax on all foreign earnings. This, in addition to the doubling of GILTI rates, has the potential to significantly increase the U.S. income tax burden for companies with international operations, depending on how such operations are structured. Conversely, a 10% tax credit is proposed for companies making investments to create jobs for U.S. workers.
Like-Kind Exchanges and Cost Recovery
The Biden plan also seeks to remove some of the tax advantages for real estate. The most significant change will be the elimination of 1031 exchanges. For those who may remember, the 2017 Tax Act significantly limited 1031 exchanges such that they would apply only to real estate transactions. Biden would eliminate such transactions entirely. Accordingly, taxpayers entering into or looking to enter into such transactions should finalize them by year's end.3
Finally, there will likely be changes to cost recovery, although few details are available at this time regarding the scope of such changes. One possibility is that the scope of property that may be 100% expensed as bonus depreciation in year one will decrease, and, instead, taxpayers will be required to recover such costs over the useful life of the property. Accordingly, taxpayers who are considering purchasing depreciable property for their business should consider finalizing such purchases and placing the property in service in 2020.
Estate Planning Considerations
Biden's tax plan would significantly alter the landscape of generational wealth transfer. One major proposed change is the elimination of a tax-free step-up in basis upon death; Biden has proposed two alternative reforms in conjunction with this change: (i) death triggering a realization event for tax purposes such that any capital gains inherent in appreciated property would be realized on the property owner's death, or (ii) a carryover in basis to the deceased taxpayer's heirs (i.e., without a tax-free step-up).
For a more in-depth discussion of the estate planning implications of Biden's tax plan, please see this alert, published by our wealth planning attorneys.
[1] This is assuming that Biden's plan will become law in 2021 and apply retroactively beginning January 1; such retroactive application is relatively common with new tax legislation.
[2] The QBI deduction was introduced as part of the 2017 Tax Act and provides a deduction for holders of certain pass-through businesses. This deduction was set to expire in 2025.
[3] It is unclear at this time whether 1031 exchanges begun in 2020 and finalized in 2021 would be subject to the old law or grandfathered into the new law.