Tax Planning in an Election Year
In 2020, companies have been forced to rethink how to operate, survive, and deal with the uncertainty caused by the coronavirus pandemic. The virus has largely dominated the news, despite 2020 being an election year, and taxpayers are still trying to gain clarity on coronavirus-related tax legislation. As we saw in 2017, this election could bring about major tax reform, so while the pandemic is far from over, it’s time to focus on tax planning considerations. Here are some highlights of what could change and some tax planning ideas to consider:
Joe Biden is proposing to raise the top tax rate for both corporations and individuals. His tax plan increases the corporate rate from 21 percent to 28 percent. The top individual rate would be increased from 37 percent to 39.6 percent. In addition, his plan would tax long-term capital gains and qualified dividends at ordinary rates on income above $1 million.
Some other notable changes in Biden’s plan include:
- Phaseout of the qualified business income (QBI) deduction for taxpayers earning more than $400,000.
- Earnings above $400,000 would be subject to the 12.4 percent Social Security payroll tax (currently for 2020, earnings above $137,700 aren’t subject to Social Security payroll tax).
- End use of like-kind exchanges.
- End estate tax stepped-up basis and potentially lower the estate tax exemption to pretax reform levels (around $5 million).
- Repeal of the temporary net operating loss (NOL) provisions within the Coronavirus Aid, Relief, and Economic Security Act (CARES Act).
- Silent on the status of 100 percent bonus depreciation.
- Cap itemized deductions at 28 percent and restore the Pease limitation for income levels above $400,000. However, the state and local tax cap would no longer apply.
- Establish a manufacturing communities tax credit, which would be a 10 percent advanceable tax credit for companies making investments that will create jobs for American workers.
If Biden wins the election and the Democrats control both chambers of Congress, a change to the code likely won’t occur in 2020. In prior elections where the parties enacted changes to tax rates, the change didn’t occur until the year after the election.
Given the potential changes listed above, here are a few tax planning strategies to consider:
- Accelerate Income & Defer Deductions: With proposed increases to tax rates, accelerating income means it will be taxed at a lower rate, while deferring deductions will result in a greater tax benefit in the future. In addition, this would enhance the benefit of the QBI deduction before a potential phaseout is enacted. Lastly, for self-employed individuals, the income accelerated would avoid the additional Social Security tax on earnings above $400,000.
- Defer Income & Accelerate Deductions: Many businesses struggling this year may end up in a NOL position. A provision in the CARES Act allows individuals and corporations to carry back NOLs five years. The top tax rate in 2015 for individuals and corporations was 39.6 percent and 35 percent, respectively. Therefore, the tax benefit of carrying back a loss could potentially provide a greater benefit than carrying it forward. In addition, since the carryback claim would be filed in 2021, you’d realize the benefit of the loss at least a year earlier than if you were to carry it forward.
- Choice of Entity: It’s a good time to analyze business structure to determine if there would be a benefit from converting to a different entity type. There are many factors, both tax and nontax, to consider when making this decision. For tax purposes, the notable changes to consider would include:
- Corporations – Tax rate increase of 7 percent plus the possibility of dividends getting taxed at ordinary rates.
- Flow-though and disregarded entities – Tax rate increase of 2.6 percent and the phaseout of the QBI deduction, which combined could increase the tax rate by 10 percent; also, the additional 12.4 percent Social Security payroll tax on earnings above $400,000.
- Capital Asset Acquisitions: Businesses should consider capital asset purchases for possible 100 percent bonus depreciation. Biden hasn’t released definitive guidance on his position as it pertains to bonus depreciation. Therefore, an asset placed in service in 2020 might generate a greater tax benefit in the year of acquisition compared to the same asset placed in service in 2021.
- Accelerate Transactions: Businesses should consider accelerating the closing of transactions in 2020 for sellers to take advantage of lower tax rates.
Business tax planning in an uncertain tax environment and economy is complex, as there are numerous tax and nontax factors to consider. Certain tax planning ideas may require action in advance of year-end, so it’s best to have these discussions with your BKD Trusted Advisor™ during your year-end planning meetings. Be sure to keep up with the BKD Tax Reform Resource Center and the BKD Simply Tax® podcast for the most up-to-date information.