Preface: With the baton of democracy peacefully transferred on January 20th, the Biden Administration now will be ideally positioned to introduce tax policy changes that should not be discounted nor unheeded with the deal making successes and cohesive union among current lawmakers.
Looking Ahead: 2021 Tax Planning for A Biden Administrations Tentative Tax Policy Revisions
Credit: Donald J. Sauder, CPA | CVA
The good news on possible tax reforms? Any proposed sweeping tax legislation from the Biden Administration for tax reform likely will only be concerning for high-income taxpayers. The bad news? A curbing of high-income earner financial appetites will result in projected shifts to economic activity and require the government to have an increasingly crucial role in replacing recent decades’ economic stimulus measures from the marketplace.
What Biden’s Tax Plan Could Change?
With the House and Senate’s passage of the Tax Cut and Jobs Act of 2017, top tax rates were reduced. A new tax reform proposal from the Biden Administration may increase the maximum rate back to near 40%, with a lower threshold applicable to an adjusted gross income of $400,000 and above.
The 199A Qualified Business Income deduction of up to 20% could perhaps be eliminated with tax reform leading to immediate increases to tax costs for Main Street business owners. This would be in addition to any possible income tax rate changes and threshold adjustments outlined above. A business that qualified under the Tax Cut and Jobs Act of 2017 for the 199A tax deduction experienced more than ideal business tax conditions—introducing new tax reforms would somewhat likely phase-out this tax-saving attribute for Main Street business owners.
Of note, while present tax reform guidance is silent on the accelerated depreciation features from the Tax Cut and Jobs Act of 2017 that were almost too good to be true for business owners, including 100% bonus deductions on both new and used capital expenditures and a substantial increase in the long-standing Section 179 tax deduction. Any proposed tax reforms may change these features of accelerated deductions on capital expenditures, and therefore, lower permissible and beneficial tax deferments, leading to high immediate tax costs.
Current information on possible reform to itemized deductions, while unknown, the possibility is likely. This would be most applicable and focused on high-income earnings, say above the $400,00 adjusted gross income threshold.
Revisions to social security taxes are also under discussion, and current proposals apply only to high-income taxpayers above the $400,000 adjusted gross income threshold.
For estate planners and high-net-worth individuals, a Biden tax reform may propose an estate exemption reduction from $11.5M to say $3.5M, resulting in increased restrictions on wealth transfers among generations with a tax-free pass. Additionally, the step-up basis of inherited assets could be eliminated. This is a tax feature whereby the cost basis of appreciated assets is increased to the fair market value in an estate transfer that therefore reduces the amount of the investment subject to capital gain or ordinary taxes on the future sale of the asset(s).
Finally, capital gains on capital asset transactions are also subject to revisions with any proposed tax reforms. Firstly, an increase in long-term capital gains from 20% to an ordinary rate of 39.6% again for high-income earnings above, say $1.0M in adjusted gross income, or when harvesting such levels of gains. Secondly, 1031 tax exchanges may be eliminated with a Biden tax reform plan. This would disallow the deferment of tax gains on the sale of a property when proceeds are invested in like-kind property and a widely used tax defer tool for real estate investments.
For business budgeting, keep foremost in mind that the higher levels of cash flow required for amortized debt payments (debt is paid with after-tax cash-flows, leverages with higher tax rates and earnings threshold) will be subject to coverage of additional tax costs. Bottom-Line of these tax reform implications? Higher tax rates from possible tax reform will lead to reduced cash flow for debt payment. Management that planned debt-financed capital expenditure payments under the Tax Cut and Jobs Act of 2017 rates in recent years, aligned with tight payments margins on cash flow, should heed this caution immediately. Prudent planning could include appropriate cash flow management plan revisions and perhaps discussions with lenders.
Trump’s tax reform for businesses with the Tax Cut and Jobs Act of 2017 may be the lowest tax rates Main Street business may see for the next decade(s). We are advising clients to defer as little taxable income as possible and capitalized on the low tax rates for the 2020 year to build equity and balance sheet strength, pay down debts, and prepare for what may be likely reforms with tax planning that will require additional diligence in cash flow management.
With the baton of democracy successful transferred on January 20th, the Biden Administration now will be ideally positioned to introduce tax policy changes that should not be discounted nor unheeded with the deal making successes and miracles of the cohesive union among current lawmakers. Please begin to plan appropriately and discussing the tax and cash flow implications with your tax advisor.