By Alex Jones, Director at Frank Hirth
In what was clearly one of the most contentious elections in US history (including the slowest possible vote count!) Joe Biden managed to secure a narrow victory. Despite recounts and potential legal challenges, it is almost certain that Biden will now be inaugurated as President, effective 20 January 2021. However, it is important to note that as just one of the four Senate seats that the Democrats were targeting changed colour, the Republicans are still expected to control the Senate (but even this is not certain due to the need for a Senate run-off election).
As news of the results are now 'confirmed', it is time for us to reconsider Biden's tax proposals and the potential impact on US taxpayers.
Of course, Biden's existing tax plans are still no more than proposals, and no doubt will develop further over the next weeks, months or even years. Of particular relevance in this regard is the fact that the Democrats do not control both houses of Congress and may have to wait another two years (for the next Senator election) to obtain control. This will no doubt increase the extent of the horse trading and compromise that will need to take place before any changes are ultimately passed. The narrow election victory, the failure to win the Senate and a reduction in their House majority may also lead to some soul searching and reflection within the Democratic party which could alter many of their plans.
Any tax changes could potentially become effective from January 1, 2021, but the failure to win the Senate make this much less likely and any major changes could easily be delayed until January 2022. This means the window for potential planning might have significantly widened from that original feared.
Let us consider what we know about his tax plans so far:
While the general theme plays to his historic democratic leanings, it might also be seen to be a response to the times, acknowledging the calls from some ultra-high net worth individuals that they ought to be taxed more in these times of COVID.
You might also think of the plans as a reversal of Trump's 2018 tax changes plus a few small extras.
The specific plans are as follows:
- A return to a top marginal individual income tax rate of 39.6% (from the present 37%)
- An increase in Corporation tax rate from 21% to 28%
- The introduction of a Corporate Minimum tax on book income
- A repeal of the 20% US pass-thru income deduction, for those with over $400k of income
- A doubling of the rate of the GILTI tax applying to the underlying income of controlled foreign companies i.e. non-US businesses owned or controlled by relevant US individuals or businesses, from 10.5% to 21% (with it is possible the real increase could be to 28% inline with the new corporation tax rate).
- An additional 6.2% social security on earnings above $400k for employee and employer, (no comment on there being a commensurate impact on social security benefits)
- A remove the preferential Long-Term Capital Gains or Qualified Dividend tax rates (currently 20%) for taxpayers with income over $1m
- A return to the 'historic norm' for the Estate and Gift Tax Lifetime Exemption, so reducing the current $11.58m exemption at least the $5.5-6m range (if not lower). He was talking at one point of reducing to the $3.5m level that Obama had suggested.
- An Elimination of the step-up in basis for inherited assets, (or a charge a capital gains tax regardless of whether a beneficiary disposed of an inherited asset or not). So, this will likely mean an inherited asset will be treated much like a gifted asset i.e. the recipient would take the original carryover basis of the decedent, NOT the value of the asset on the date of death. There has been some reference by some commentators of the alternative taxing the unrealised gains on the death, albeit with a $100,000 exclusion, although that sounds like it could create a fair amount of complexity depending on how applied. There has also been some speculation on possible changes to valuation rules in the context of certain business assets and such hard to value assets.
- A repeal of the like-kind exchange treatment applicable to real property, which Trump had previously preserved despite removing the ability on other assets
- A limitation on the tax benefit to be derived from itemized deductions to 28% for those in the higher income tax brackets
- A restoration of the so-called 'Pease' limitations on Itemized Deductions for those with income over $400k which can phase out up to 80% of the deductible amount
- The introduction of an $8,000 tax credit for childcare
Importantly there is still no mention of the introduction of a Wealth Tax or a Financial Transaction Tax. Biden will also be under immense pressure to repeal the $10,000 cap on State and Local tax deductions, albeit such a move would be limited by only giving relief at a 28% rate for higher-income taxpayers as mentioned above.
So, if Biden sticks to these plans US taxpayers would be advised to review their investments and expenses. Actions to consider would include:
- Accelerate the realization of capital gains to secure the 20% Long-Term Gain Rate (not forgetting the additional 3.8% Net Investment Income Tax)
- Accelerate the realising of compensation into 2020 (e.g. exercise of stock options or agreement with employer to pre-pay bonuses)
- Defer realizing Long-Term Capital Losses until the higher gain rates come into effect
- Accelerate qualifying itemized deductions to the extent you have exposure to tax rates greater than 28% at present
- Defer State and local tax payments into a later year when they might be more deductible against federal income.
- Placing assets in life insurance vehicles (which are taxed as income on exit) may become even more attractive if the Long-Term Gains Rate is also at top marginal income tax rates
- Consider if possible, more fully utilizing the current $11.58m lifetime Estate & Gift Tax Exemption, before it is reduced, (the IRS has previously confirmed they would not later claw back the difference). This could include funding a trust or using a family limited partnership structure
- Refreshing any Will planning with particularly emphasis on the treatment of highly appreciated assets, e.g. it may be preferential for pregnant gains to be realized pre-death rather than by an estate, to the extent the income tax could reduce the value of the estate, particularly with a lower exemption
- As always for American's living overseas all these thoughts and more need to be balanced together with the relevant local tax position.
The impact of Biden's proposals on non-US tax residents is likely to be very limited with only those with income or gains from US businesses/Property expected to incur additional taxes.