Prior to the presidential election, one of the year-end focuses for tax planning was on a possible presidential victory for Joe Biden combined with a Democratic majority in the Senate that might result in tax increases in 2021 for higher-income individuals, corporations, investors, and estates. Biden has now been declared the victor of the presidential election. However, it appears possible that the Republicans may retain control of the Senate, and the issue may not be decided until two run-off elections in Georgia in January 2021. So control of the Senate may not be decided before year-end, making year-end planning based on the election results still something of a guessing game.
Planning for a Republican Senate
The possibility of a continued split government means that President-elect Biden may have difficulty getting his tax plans enacted into law. The stock market has been heading higher since the election, with investors betting on that result. One caution on that euphoria is that even the Republican Senate may feel the need at some point to address the growing federal deficit that has come about as a result of the tax cuts in the Tax Cuts and Jobs Act and the pandemic relief provided in the CARES Act. In addition, it is possible that additional pandemic relief might be enacted either in the lame duck session this year or early in 2021.
With less concern about significant tax increases early in 2021, the year-end tax planning focus can return to some of the more traditional strategies. Assuming that individual tax rates are not expected to increase in 2021, individual taxpayers can focus on the usual strategies of postponing income and accelerating deductions. Strategies to postpone income start with checking current projected income for 2020 and 2021, checking how that income might fall into the individual tax brackets, and determining if the taxpayer might be pushed into a higher bracket. While many wage earners and salaried employees may have limited control over the timing of their income, self-employed individuals may be able to postpone income by postponing billing, and employees expecting year-end bonuses may be able to negotiate to have those bonuses paid in 2021 rather than 2020. Corporations may similarly be able to postpone income into 2021 with less fear of a corporate rate hike in 2021.
The corollary to postponing income into 2021 is accelerating deductions into 2020. With higher standard deduction amounts, a bunching strategy for itemized deductions may be even more important, taking the standard deduction every other year and bunching itemized deductions such as charitable contributions or perhaps medical deductions into the off year for the standard deduction. This year may be a good year to bunch itemized deductions with higher limits on charitable contributions and a lower 7.5 percent threshold for medical expenses only available for 2020, although it may be getting a little late in the year to squeeze in some elective surgery. Non-itemizers can look to the $300 above-the-line charitable contribution, also under current law only available in 2020. There are also over 30 regularly expiring provisions currently expiring at the end of 2020, with the individual provisions including the tuition and fees deduction, the mortgage insurance premium deduction, the exclusion for mortgage debt forgiveness, the nonbusiness energy property credit, and a couple of vehicle credits.
Investors with less concern about a capital gain rate increase in 2021 may be able to focus on the usual year-end strategy of looking over their investment portfolio for holdings they might wish to sell and see how their capital gains and losses for the year match up in deciding whether to do the sale in 2020 or 2021. Capital gains realized might be subject not only to the capital gain tax rates but also the 3.8 percent tax on net investment income.
With less concern about increased tax rates in 2021, individuals may be less concerned about getting Roth IRA conversions done this year. However, retirement planning should continue to focus on changes to the new distribution rules for IRA beneficiaries and the ability to continue to make IRA contributions after age 70 ½ if there is enough earned income to support them.
Estate and gift planning also may require less of a year-end focus with less risk of a reduction in the unified credit in 2021 or an increase in estate and gift tax rates in 2021. However, low interest rates may make a year-end gifting program still attractive, although low interest rates are also expected to continue into 2021.
Planning for a Democratic Senate
At the point of this writing, the elections have so far produced an even 48-48 split in the Senate with Alaska and North Carolina undecided but leaning Republican and two races in Georgia scheduled for run-offs in January, 2021. Should both Democrats win in the run-off elections, the result could create a 50-50 tie in the Senate if the Republicans have held onto the other two undecided races.
This creates a scenario in which President-elect Biden may have a greater chance of enacting his proposed tax increases in 2021, including higher individual tax rates for taxpayers earning over $400,000, higher capital gains tax rates on higher income taxpayers, a higher corporate tax rate, and possible higher estate and gift tax rates and reduced exemption amounts. It may still be possible to plan for such contingencies in 2021 before they take effect but there is no guarantee of that at this point. While Congress frequently makes tax breaks retroactive, it has been more reluctant to do so with tax increases. Sometimes Congress has made tax increases retroactive at least to the beginning of the year when it feels that the intention to enact the tax increases has been made evident ahead of time.
Taxpayers who are concerned about tax increases in 2021 might change the normal year-end tax strategies. This would include accelerating income and postponing deductions for both individuals and corporations, taking a harder look at realizing capital gains in 2020, considering Roth conversions in 2020, and looking at making lifetime gifts in 2020. Again, there might be a window to take such actions in 2021 before tax increases would take effect, but that is not a certainty.
Summary
Biden has won the presidency, but whether the Democrats control the Senate will not be known for sure until 2021. President-elect Biden’s tax increase proposals may not be enacted without Democratic control of the Senate, but history indicates that new presidents often are successful in enacting their tax proposals early in their presidency if their party also controls Congress. Post-election tax planning for possible tax increases in 2021 therefore requires gazing into your crystal ball and planning accordingly.
