By Robert Jackson, CPA | Senior Manager, Tax
Monday, November 16, 2020
It is the middle of November, fresh off the general election, and for most taxpayers, it is the height of tax planning season. While many taxpayers and professionals alike were expecting to have a clearer picture of what 2021 (as well as the end of 2020) would look like from a tax perspective, many of us are still faced with questions. Though we cannot predict the future, there are several items that taxpayers should be considering between now and the end of the calendar year.
New Tax Legislation for 2021
Due to the situation in Georgia, we will not know which party will control the Senate in 2021 until after the end of 2020. Why is this important? With Democrats already controlling the House and (likely the) presidency in 2021, adding a Democrat-controlled Senate into the mix could increase the chances of bringing some of President-elect Biden’s tax policies to fruition in 2021, either through the budget reconciliation process or the elimination of the filibuster (both of which would result in requiring only a simple majority to pass a bill).
On the other hand, a Republican controlled Senate decreases the chances of Biden’s tax policies being passed into law, because holding the majority and voting along party lines would allow the Republicans to block legislation (including through the budget reconciliation process) in the Senate. In fact, simply holding a majority may even prevent votes on the floor, which has occurred in the past.
And of course, because of how close the split will be, we also need to consider the possibility that not all senators will vote along party lines, possibly swinging control from one party to the other on a particular legislative bill.
New Tax Legislation Before the end of 2020
There will almost certainly be legislation before the end of the year, as the federal government faces a shutdown if a funding bill is not passed before a December 11th deadline. However, it is not clear as to whether that legislation will include any tax provisions.
The Democrats’ latest release of the Heroes Act (which was passed by the House of Representatives but not by the Senate) at the end of September 2020, contains a number of tax provisions related to Covid-19 relief, including clarifying that expenses used for forgiveness of a Payroll Protection Program (PPP) loan will be deductible (i.e., reversing the current position of the IRS), but also removing some of the more tax-friendly provisions of the CARES Act (such as the allowance of NOL carrybacks and suspension of the excess business loss limits for noncorporate taxpayers).
However, Senate Republicans just released their version of a funding bill this week that did not contain any Covid-19 relief or related tax changes. This is consistent with the position that the Republicans want to address Covid-19 relief (and possible related tax provisions) in a separate bill, which would mean that there is less of a chance that the two sides would come to an agreement before year-end.
Select Highlights of Biden’s Tax Plan
As many are already aware, Biden has proposed some significant tax increases targeted at wealthy individuals and corporations. Below are just some of the items from Biden’s tax plan that should be on everyone’s radar when making decisions in the next two months:
- Marginal maximum ordinary income tax rates are proposed to increase back to 39.6% for individuals, and the long-term capital gains rate (as well as for qualified dividends) could also increase to 39.6% for taxpayers with $1,000,000 or more of taxable income.
- Like-kind exchange tax deferrals would no longer be available for those individuals with incomes over $400,000.
- The corporate income tax rate is proposed to increase to 28%, along with a 15% minimum tax on book income.
- Increase in social security taxes on wages over $400,000 (this could include stock options/restricted stock).
- Eliminate step-up in basis at death and/or taxing unrealized gains at death.
- Potential reduction of the unified credit for estate tax purposes.
Existing Items to Consider in Planning
The CARES Act, which was passed earlier this year, created several provisions that should be considered before year-end. Below are some of the significant provisions:
- 80% Net Operating Loss (NOL) limit removed by CARES Act for 2020 (limit reinstated for 2021 and forward for post-2017 NOLs).
- 2020 NOL can be carried back 5 years (no carryback for 2021 and forward NOLs).
- Excess business loss limitation for noncorporate taxpayers removed for 2020 (limit reinstated for 2021 and forward).
- Relaxed AGI and taxable income limits for certain cash charitable contributions (2020 only).
- Bonus depreciation on Qualified Improvement Property.
- PPP Loan Forgiveness (current IRS position is that expenses that lead to forgiveness will not be deductible in 2020).
Of course, there are many other items to consider aside from the CARES Act, namely limitations of losses (such as the passive loss rules or at-risk rules), the interest deduction limitations (50% in 2020), the qualified business income (QBI) deduction, taxable income from taking certain payroll tax credits (i.e., sick leave, employee retention credit), bonus depreciation/section 179 elections (and timing of purchases) and accounting method changes (i.e. such as accrual to cash). Also, keep in mind that you can decide not to elect bonus or section 179 and as well as deciding after year-end to change most accounting methods. You can also elect to carry NOLs forward.
What Can be Done Before Year-End?
Assuming funding legislation is enacted before December 11, but further assuming that the legislation does not address PPP loan forgiveness, taxpayers should plan to set aside funds now to cover any additional tax that may result assuming their forgiveness amount is taxable. This is because the current IRS position is that a taxpayer will have taxable income in 2020 equal to their loan forgiveness amount, via a disallowance of deductions.
For those taxpayers hoping to defer the taxable income from the PPP loan forgiveness to 2021 (which is not the current IRS position), they may want to consider waiting until 2021 to file for forgiveness. While the year of filing does not control the year of taxable income under the current IRS position, that could change. Therefore, filing for forgiveness in 2021 creates a small chance of deferring the taxable income impact until 2021.
In terms of specific items from President-elect Biden’s tax policy – a cursory review of his proposals, at the very least, puts taxpayers and their advisors on notice of potential changes in tax rates (income and social security tax) and the possible reduction of the estate tax exemption during his regime. Considering this, taxpayers with adequate cash flow may want to consider accelerating income in 2020 and deferring deductions until 2021, and those with taxable estates should consider gifting by year-end to maximize utilization of their unified credit.
But despite the possibility of increasing rates, accelerating income or deferring deductions would not be the choice taxpayers will make in all cases. Consider the following examples, for instance –
- Taxpayers with income in the carryback period may want to create or increase a loss by deferring income or accelerating deductions in 2020 to get back tax already paid (via an NOL carryback).
- Given the current IRS position, borrowers of PPP loans may want to accelerate deductions to offset the expected taxable income in 2020 from loan forgiveness.
- Other taxpayers will deal with certainty and look to reduce taxes now, even if they expect a rate increase.
As stated throughout this article, though there are several items to consider before year-end, there is no steadfast universal rule that will help all taxpayers deal with the current uncertainty. Each situation is unique so each taxpayer will need to consider the items above (among others), including assessing risk and analyzing projections and expected cash flow consequences. Though the process can be complicated, Apple Growth Partners is here to help you navigate through the options. Please contact your team at AGP to discuss any further questions and to begin year-end planning.