In this year like no other, looking ahead is preferable to looking back. But while 2020 has been, to put it mildly, tumultuous, things look relatively calm on the tax policy horizon in the short-term future.
Year-end tax planning always involves some uncertainty, but more this year than most. Democrats won the White House last month, but Senate control is still up in the air at this writing, pending a pair of runoff elections in my home state of Georgia in January. Right now, it appears unlikely that Democrats will win both races, which they would need for a bare Senate majority. Even if they pull it off, their majority will be razor-thin – a 50-50 split, with Vice President Kamala Harris as the tie-breaking vote. This count includes many moderate Democrats who are not interested in extreme reform. The party’s majority in the House of Representatives is not overwhelming, either. Under these circumstances, taxpayers can expect either no change to the tax laws at all or minor adjustments (at least before the 2022 midterm elections).
It is not absurd to consider the prospect of higher tax rates under a Democratic president, even if the chances of a Congress willing to push for major changes seems slim. At the same time, it is important to remember that campaign promises don’t always directly translate into policy, even with a legislature sympathetic to the executive branch’s goals. A candidate’s platform is more of a wish list than a road map, even in ideal circumstances. Biden’s proposals included higher individual income tax rates for taxpayers who earn more than $400,000 a year, higher capital gains taxes for taxpayers with income greater than $1 million, and eliminating the basis step-up for inherited assets. On the campaign trail, Biden also proposed limiting the benefits of itemized deductions for upper-income taxpayers.
One of Biden’s most conspicuous campaign pledges was a plan to forgive outstanding student debt. This, too, could have tax consequences. Under ordinary circumstances, debt forgiveness is a taxable event. If Biden acts unilaterally, using an executive order, it is likely the normal rules will apply. Lawmakers could create a means of tax-free debt forgiveness if they wish, or provide relief for debt forgiveness created by the executive branch. They might exempt all forgiven loans, or only those held by taxpayers under a certain income threshold. It is too early to guess how Congress, or the White House, will pursue this policy item, but taxpayers with significant educational debt might face a one-time bump up to a higher tax bracket.
For now, while the state of Congress and Biden’s in-office priorities remain unknown, taxpayers can only make educated guesses. But that does not mean they should neglect year-end tax planning altogether.
If you know you plan to sell an appreciated asset and you can get a fair price for it now, it may be worth selling it in December. Even if capital gains tax rates rise less than Biden’s original proposal, you may as well take advantage of the window before legislators can close it. Any tax changes that happen later in 2021 could be retroactive to the beginning of the year. While Congress is generally more eager to apply retroactive tax breaks than tax increases, the latter isn’t unheard of.
You may have appreciated property that is harder to value or sell than stock. If you want to harvest gains on real estate, art or a stake in a private business, for example, working out a fair deal before the end of the year may seem daunting. Depending on your circumstances, you may want to consider selling to a family member or a trust to streamline the process. In certain scenarios, it could even make sense to arrange a taxable barter transaction with someone who owns a similar asset, so you can both reset your basis. If you wish to pursue any of these more flexible approaches, it is a good idea to consult a professional to make sure the sale or trade works the way you want it to.
If you are in a position to do so, you may also want to accelerate income this year ahead of a potential rise in income taxes. This could take the form of exercising stock options, asking to receive an announced bonus before year-end, or billing for completed work as soon as possible. You can also convert a traditional individual retirement account into a Roth IRA, if you had plans to do so. A conversion is a taxable event, so if you think you will be in a higher bracket later – either because of your personal situation or because you expect tax rates to rise – getting the conversion done in 2020 may have benefits. If you have appreciated assets in a taxable investment account, you could also harvest them, especially with the market having bounced back from its early-2020 lows. As always, if you have potential capital losses, you can also use them to offset capital gains to lower your tax bill, regardless of the capital gains tax rate (or other tax considerations like net investment income tax).
The other side of the coin from accelerating income is deferring deductions, which can help offset higher income tax rates in the future. If you live in a high-tax state, this strategy may be especially attractive in light of the potential downfall of the $10,000 cap on state and local tax deductions. The SALT cap will disappear in 2025 unless Congress renews it, but lawmakers could ax it even sooner. Biden discussed getting rid of it during the campaign, and the prospects for bipartisan support may be higher than some of his other proposals. The cap disproportionately affects residents of Democratic bulwarks like New York and California, and it is likely to be a principal target if Democrats can only expect to partially roll back the 2017 tax reform package.
Gift and estate taxes are unlikely to change much in 2021. Biden has proposed reducing the combined exemption from its current level, $11.58 million, down to $3.5 million. This proposal is probably a nonstarter for at least the next year or two, especially if Republicans retain Senate control. But if you prefer not to risk it, making gifts now could be wise if you plan to make them soon anyway. Bear in mind that, unless lawmakers extend it, the current higher exemption will automatically revert to a lower level in 2025.
You may find yourself in a position where it makes more sense to accelerate deductions into this year, regardless of the potential for rising rates. If you had a particularly income-heavy year that is unlikely to repeat, timing deductions accordingly can be a wise move. Especially with a high standard deduction in place, bunching deductions within a tax year can make itemizing more attractive.
One of the deductions you can time most easily is the one for charitable gifts. If you are philanthropically inclined, giving before year-end is a straightforward way to accelerate deductions. If you don’t have a particular recipient in mind, you can also give appreciated securities to a donor-advised fund. Any unrealized gains will escape taxation, and your contributions can be invested aggressively or conservatively. In the future, you can request distributions from the fund to charities you select. Even if you don’t suggest a recipient until years later, you can still deduct the gift right away.
This is an especially attractive year to bunch charitable contributions, because the CARES Act specified that taxpayers can contribute up to $300 in cash gifts “above the line,” an added benefit that will only apply to 2020 (unless lawmakers opt to extend it). Remember that you also can give appreciated assets directly to a charitable recipient without triggering any capital gains tax. The CARES Act allows donors to deduct such gifts up to 100% of their adjusted gross income. (Gifts to donor-advised funds remain capped at a lower amount.) If you have assets that have declined in value, it usually makes more sense to sell the asset and recognize the loss, and then give the cash proceeds to your recipient.
More than most years, 2020 brings uncertainty to the tax planning table. But even though the political situation will not be clear for several weeks, most taxpayers can benefit from reflecting on their individual situations and evaluating potential moves to make before Jan. 1. No one has a crystal ball, but it seems likely taxpayers can expect a relatively calm 2021 – at least when it comes to tax law changes.