It appears likely that the Democrat party will now have control of Congress.
At the time of writing this, the Georgia Senate runoff election has declared one of the two Democrats running a victor, and the other leads in the vote count but it is “too close to call”.
If both Democrats are declared winners, it puts the Senate count at 50-50 Democrats and Republicans. When there is a tie in the Senate vote, the Vice President of the United States acts as the tiebreaker.
Democrats still maintain a majority in the House, so if all Democrat Congress members vote with their party, they could enact changes to the tax law as early as the first half of 2021.
What could this mean for your taxes moving forward?
First, you should understand that a Democrat-controlled Congress does not mean that all Democrat members will vote with their party. It’s no secret that most politicians are influenced by big-money donors. If the politician wants to get re-elected (and almost all of them do), they will be pressured to vote however the big money wants them to vote. At the same time, there are more ‘progressive’ Democrat members who would like to see very large tax increases and may not vote for anything less than that.
Also, a tax reform bill may not be the top priority for the Biden administration. The consensus among tax policy experts is that such a bill would likely not be voted on in 2021.
Regardless, it is prudent to understand how potential changes in the near future could impact you.
So, what tax changes do the Democrats want to make?
The best indication we have for now is what President-Elect Biden campaigned on. Some of the highlights are:
Increasing the top tax bracket from 37% to 39.6%
Taxing long-term capital gains and dividends at ordinary tax rates (instead of the lower capital gains rates) for taxpayers with income over $1 million
Significant increases to estate taxes (aka “death tax”)
Increasing the tax on C Corporations from 21% to 28%
Eliminate the 20% Qualified Business Income Deduction (QBID) for taxpayers with income over $400,000
Most of the above potential changes are fairly straight-forward to understand, while the death tax changes require more explanation.
Biden’s Estate Tax Proposal
Current law provides that upon death, assets of a taxpayer are transferred to heirs tax-free, up to $11.7 million for an individual and $23.4 million for a married couple. Any assets above those exemption levels are taxed at 40% (generally). While Biden has not given a specific number for his desired estate tax exemption, the consensus is that his number is $3.5 million for an individual and $7 million for a married couple.
If you believe you will be over the lower, proposed exemption level, you should think about gifting assets now, before a new law is passed.
If you are planning to transfer assets to your heirs upon your death, but believe you will be below the $3.5/$7 million thresholds, you are still not safe from potential estate tax increases!
Biden has proposed eliminating the “step-up in basis” benefits. Currently, the basis of inherited property is “stepped-up” to the property’s fair market value on the decedent’s date of death, effectively eliminating all capital gains on the pre-death appreciation.
Example: Assume you started a business many years ago with $25,000. Ignoring complicated tax laws dealing with changes in basis throughout the years, that $25,000 is your “tax basis” in the business today. You worked hard for decades to build up the business and now the fair market value of the business is $3,000,000. If you sold it to a third party before your death, you would pay tax on $2,975,000 of income (the difference between the sale price and the basis). Assuming the gain on sale is taxed at a 20% federal capital gains rate, you pay $595,000 in taxes.However, let’s say one or more of your children works in the business with you and you plan to pass it on to them. Under current law, you would probably wait until your death to pass it on (rather than gifting it during your lifetime) because your heirs would then have a basis of $3,000,000 in the company (basis step-up). You would, effectively, be leaving them with $595,000 more than if you gifted it before your death. If your children sold the business 6 months after your death for $3,000,000, they would pay zero tax on the sale. Under Biden’s proposal, your children would not get the step-up in basis upon your death. Their basis would be $25,000 and they would have to pay the same tax you would if you sold the business before your death.
It is possible that tax law changes could be effective for the 2021 tax year. But changes to estate taxes would likely be effective the date that the law is enacted.
While all of this is speculation at this point, planning ahead (or not) could make a huge financial impact on you and your legacy.
If you have any questions about these potential tax policy changes or wish to begin evaluating the impact to you, please contact our Wayfinder CPA tax planning professionals.