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If you're confused about the current tax situation, you're not alone. When the Tax Cuts and Jobs Act (TCJA) went into effect in 2018, it was supposed to lower taxes for everyone and simplify tax filing. Do you remember the promise of a tax return on a postcard? Instead, the IRS added Schedules 1, 2, and 3 in addition to the hundreds of new and existing specialized tax schedules. The SECURE Act of 2019 followed and disrupted—uh, I mean “improved”—the way Americans save for retirement. In 2020 Congress' COVID response introduced an alphabet soup of relief packages, including the CARES Act of 2020, which added PPP loans, EIDL advances, and the PUA program to the mix, waived 2020 retirement distributions, expanded 401(k) loans, and much, much more. As I write, all eyes are on Congress as they consider yet another stimulus bill.
On the heels of massive change, the Biden administration heads to the White House on January 20, 2021. This week I attended two days of professional education to update advisors on changes to Federal and California state taxes. The session covered all the above tax legislation and discussed how Biden's campaign plan might translate into future legislation. My mission was to understand the changes and devise strategies to help my clients prepare for what's ahead. Here were my key takeaways:
Tax rates will (probably) go up.
At the moment, tax rates are the lowest they have been in history. With a new administration soon to enter the White House, that is almost certain to change. Candidate Biden's tax plan proposed raising taxes on those with income above $400,000. He wanted to increase the top marginal rate from the current maximum of 37% to 39.6%. At least in theory, if you have an AGI over $523,600 for single filers or over $628,300 if married/filing jointly, you may be affected by the higher rate. And if you’re wondering if that $400,000 applies to individuals or to a household, no one knows—yet. What will President-elect Biden propose? That, too, remains to be seen. Regardless, any proposal requires Congressional approval, and that probably won't be a slam-dunk unless democrats end up controlling both houses of Congress—which seems unlikely.
Unemployment recipients may be in for a surprise.
Unemployment income is federally taxable but state-tax-free. During the pandemic, unemployed workers received regular unemployment, plus bonus payments of $600/week provided by the CARES Act. While tax was withheld from regular unemployment, no tax was withheld from the CARES bonus payments. That means those who received unemployment benefits may have an unwelcome surprise when they owe additional taxes. It will be even worse if they are still unemployed. If you received unemployment benefits this year, consider prepaying those taxes now to avoid a potential penalty or, at the very least, calculate what you owe and set that money aside so you’re prepared when the bill comes due.
The step-up in basis on inherited assets may be eliminated.
This was another hot topic during the presidential debates leading up to the 2020 election, but it's not a new conversation. The Biden tax plan (at least as it was presented during the campaign) calls for the repeal of the stepped-up basis on assets at death. This means that at the time of an individual's death, the beneficiaries pay capital gains taxes if they sell the asset. I think eliminating the step-up is a challenging change, if for no other reason than how difficult it would be to calculate the basis of certain assets; for example, how do you calculate the basis of the house your mom lives in… the one she inherited from your grandma ages ago? Strategies to deal with this include lifetime gifts to heirs, donating appreciated securities, realizing gains and refreshing basis, and more.
Estate taxes could go up.
The Tax Cuts and Jobs Act of 2017 increased the estate exemption to $11.180 million. That means that there are no inheritance taxes until an estate exceeds $11 million. This provision sunsets (ends) in 2026 and is slated to return to the pre-2018 level of $5.450 million—unless Congress Acts. The current estate tax rate is 40%; in 1997, it was 55%. We're watching this one and will discuss how any change that does take place affects your legacy plan.
The dark side of balancing the budget.
Tax cuts, pandemic relief, stimulus payments, and recession have resulted in record deficits. I anticipate that ‘deficit hawks’ will want to solve this ‘problem.’ When COVID subsides, will Congress demand that new programs follow the PAYGO budget rule which requires that legislation that affects tax revenue and entitlements doesn’t increase deficits? Do deficits really matter? To rebuild the economy, we need to spend and invest. Modern monetary policy views deficit spending as good as long as it increases productivity and incomes. The tension between Modern Monetary Policy and Deficit Reduction goes to the heart of what kind of society we want. Deficit hawks may wish to reduce entitlement and social programs. Modern Monetary Policy advocates may wish to promote infrastructure, health care, public education, and basic income. My position is that any program that makes the pie bigger and ensures that children and the elderly are cared for is good economic policy.
The inherited IRA we loved is gone.
The SECURE Act requires that inherited retirement accounts must be distributed in a ten-year period. This is a big deal if you intended to leave your IRA to your children and give them lifetime income. There are exceptions to the rule for spouses, but it is still a major change that may require an adjustment in your strategy to fulfill your intent. We’ll review this in the spring.
Tax rules are always changing, and it can be hard to keep up. (It's no wonder I still have clients asking about 'income averaging' and if they need to buy a new house when they sell one—both tax strategies that were wiped away years ago!) My job and my commitment to you is to stay informed about the most recent changes and to align your tax strategy as needed. The good news is that, aside from the unemployment tax issue, almost every potential change covered during last week's tax sessions was related to estate planning. I heard nothing that should add to your stress.
Looking ahead to 2021, we plan to make estate planning a focus for our second-quarter client reviews. By then, we should have a much better sense of which way Congress is leaning and what steps we can take to help mitigate your taxes moving forward. Until then, know that we are doing everything necessary to be sure you are positioned well for tax season and 2021. If I do get wind of anything urgent related to your taxes or anything else that could impact your financial life, I will certainly let you know. For now, relax (about taxes, anyway), enjoy the holiday season, and stay safe. And as always, if you have any questions or concerns, don't hesitate to reach out. I am here to help—during tax season and all year round.
Related: 6 Ways a Financial Advisor Can Improve Your Return on Life!