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Year End Tax Planning Considerations Under A Biden Tax Plan

Dec 17, 2020 | Business Health, Investing, Tax

As the close of year 2020 is rapidly approaching, I’d like to mention a few tax planning thoughts that should be considered before year-end, assuming that the Senate changes hands before the start of the President Elect’s administration. Keep in mind that in order for the President Elect to get his plan through Congress, he will have to either have a majority of the Senate on his side or know that he has the votes in pocket via some other form of horse trading. As we’ve learned over this past four years, we never know what’s in store for the American populous. Nevertheless, our job is to make our clients aware of the possible added taxes they could be confronted with and then to provide alternatives to mitigate those costs. In the following passages, I’ll attempt to highlight some of those tax changes that are being discussed for the coming years and then suggest ways to attempt to mitigate those possible increases if they could impact you personally.

  • The top individual income tax rate for taxable incomes above $400,000 will revert to the pre-Tax Cuts and Jobs Act level of 39.6% from 37% under current law. For the 2020 tax year, this top marginal rate is applied to earned income above $518,400 for single filers and more than $622,050 for married couples filing jointly.
    • If you expect that your income will exceed the $400,000 threshold in 2021, you may want to consider accelerating business revenue or decelerating business expenses before the close of year 2020. By doing this, you would certainly be increasing your current tax costs, which we normally don’t recommend, but considering the proposed climb in rates, we could see benefits to doing so. An acceleration of $100,000 of income into year 2020 would see an increase in your 2020 tax liability of $37,000, before consideration of a qualified business income deduction (QBID), but could quite possibly save you $2, in federal income tax between years 2020 and 2021, and significantly more if you consider the possible savings from QBID (more to follow on this topic).
  • A limit of 28% on itemized deductions. For each dollar of itemized tax deductions, including charitable contributions, a taxpayer or couple filing jointly would only receive a maximum benefit of $0.28. This 28% limit would hold true even if a filer is paying a higher marginal tax rate.
    • Consider bunching your charitable contributions into year 2020, especially if you are a high earner. Assuming you fall into one of the higher tax brackets (greater than 24%), the tax savings created by bunching your charitable giving into year 2020 could be worth anywhere from 4% to 11.6% of those dollars contributed.
    • Consider timing the recognition of interest expense, if at all possible, given the 28% deduction limitation. This option has a few moving parts and may require more analysis with your accountant, but nevertheless, it’s worth considering.
    • Capital gains and qualified dividends have historically been subject to favorable capital gains tax rates. For top income earners, this rate is currently capped at 20%. Under the Biden proposal, capital gains and qualified dividends will be subject to the top rate of 39.6% for individuals with more than $1 million in income.
        • Consider locking in profits on appreciated stocks before year-end, if you happen to be a taxpayer who could be impacted by this proposal. This again would create the acceleration of taxes into year 2020, and should be given serious consideration before adoption. Moreover, there are other considerations that should be a part of your decision making process as you ponder this idea. First, assuming you like the investments you are considering selling, you can, in effect, provide yourself with a faux step up in basis given the fact that nothing precludes you from immediately reacquiring these securities at the start of the new year.
        • If you are planning on selling stock at a loss, consider holding off until the new year, assuming those losses will be available to reduce gains in 2021 and forward, or will be available to offset higher rated income. Also, keep in mind that stocks sold at a loss cannot be reacquired within 30 days prior to, or 30 days after the sale, or else you will be precluded from realizing that loss on your current year’s return.
        • Also, the President Elect’s plan calls for the nullifying of a step up in basis for those assets left to your heirs. Thus, a bird in the hand may be worth paying the taxes today rather than from your trust or estate, which could possibly be more expensive.
        • If you have significant net worth and a significant build up of unrealized gains within your portfolio, consider a gifting plan that would allow you to pass on those gains to your heirs and quite possibly save on taxes while doing so. Again, as the step-up in basis concept is being considered for repeal, a gifting strategy may make even more sense. However, keep in mind that if your annual gifts to an individual exceed $15,000 in fair market value, a gift tax return should be filed.
        • Consider repositioning your investments from dividend paying securities, or from funds that distribute capital gains, into tax exempt investments or growth investments. Before doing so, you’ll certainly want to review how long your time horizon is before you’ll need to draw down on your investments, and also whether you’ll need the cash flow generated from the dividends. It’s possible to save on taxes by repositioning your investments, but sometimes the path best traveled is the road you’re already on. Possible tax savings may not be worth the added risk necessary to achieve it.
        • Also, if your potential income in year 2021 and beyond is bordering on the $1 million threshold, be sure to ask your accountant if a tax projection is warranted to attempt to mitigate the added tax costs associated with your capital gains and qualified dividend income.
      • Phasing out of the qualified business income deduction (Section 199A) for filers with taxable incomes above $400,000. As the law stands now, the qualified pass through business deduction allows small business owners to deduct up to 20% of their business income under the TCJA, which in effect converts the top tax bracket on that income from 37% down to 29.6%.
        • Again, as mentioned in our above examples, protecting against this proposed change would require the acceleration of income into year 2020 and the accelerated payment of the added tax on that income. However, the magnitude of this potential savings cannot be overstated, given the rise from 37% to 39.6% in the top tax rate and the potential loss of a 10% QBID tax savings. As an example, assume you have the option of moving $500,000 into year 2020 versus 2021, and further assume that you are in the top tax bracket for both of those years and that you are exposed to the loss of the QBID in year 2021. The short of it is that, excluding consideration of the possible underlying incremental tax impacts within your returns, your added tax in year 2021 by not accelerating income into 2020 will be $50,000. (39.6% versus 29.6% times $500,000). I would suspect that a tax increase of $50,000 certainly warrants discussion on this topic before year-end. I’ll also mention that the incremental tax savings should not be looked at in a vacuum, since other business considerations could outweigh the lost tax savings. For instance, how will the pandemic impact the supply chains of your business? Could you be looking at inventory shortfalls next year that may impact 2021 revenue and, if so, is it a prudent decision to accelerate versus taking a wait and see approach?

Considerations for 2021 and Beyond

      • Wages in excess of $400,000 would be subject to the OASDI tax, often referred to as the Social Security tax. By way of explanation, Social Security benefits are paid to workers who retire or are disabled and to surviving family members if a worker dies. OASDI tax revenues are placed into trust funds. The Social Security Administration then draws on the trust funds to provide benefits. Historically, wages subject to social security were capped, and in year 2020 that cap was set at $137,700. In 2021 and beyond under the Biden plan, the OASDI wage will continue to be inflation adjusted, but will pick up again at the $400,000 mark. This is what is considered the doughnut hole for the OASDI wage base and could have a significant negative tax impact on those earners who receive more than $400,000 in self-employment income and/or wages.
        • If you haven’t already done so, and your individual compensation warrants, you may want to consider converting some of your W-2 income into profits distributions if you operate as a S-corp. However, be aware that the “reasonable compensation” theory still exists and should be maintained if you plan to reposition compensation. You may also want to consider putting your spouse to work and on payroll, assuming you have a long enough time horizon where future earnings would have an impact on their own social security benefit, versus collecting a spousal benefit. This will take a bit of computing to cash flow this option out, but one I’m sure your accountant would be glad to assist you with.
        • If you operate as a single member LLC, a sole proprietorship or a partnership, year 2021 may be the year that drives you to revisit the opportunity to convert your business to an S-corp for tax purposes. Again, your accountant can help you through the decision process if you’re considering this option.

We can’t know what future tax policy will be, but we have to expect change in coming. Please contact us for assistance in developing the best strategies to address those changes.

Article submitted by Thomas J. Freund, CPA

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