In our July newsletter, we wrote briefly about the potential for changes in tax law, especially in light of the approaching presidential election and the rapid fiscal expansion that took place in 2020 in response to COVID-19. As we near Election Day, tax issues have become even more of a campaign talking point, especially since the NY Times’ reports and allegations surrounding President Trump’s annual tax returns.
With the CBO projecting a federal budget deficit of $3.3 trillion for 2020 (at 16% of GDP, the largest fiscal shortfall since 1945), it seems inevitable that at least some small tweaks to tax policy are imminent, likely regardless of who ends up controlling the various branches of government. For many of us, this renewed emphasis on tax planning might spur a sense of déjà vu, coming on the heels of the 2017 Tax Cuts and Jobs Act (TCJA), the 2019 SECURE Act, and the 2020 CARES Act, all of which had implications for tax and retirement planning. Nevertheless, we’ll try our best to put some context around the political posturing, in order to hopefully help frame the relevant tax issues, on both a national and a personal planning level.
A long history of tax-hike hysteria
Discussions about tax policy are something of a national tradition during our quadrennial presidential elections, regardless of the specific candidates on the ballot. More often than not, elections are won and lost on other issues, with taxes typically representing a secondary consideration. There are, however, some exceptions, including the 2008 Barack Obama-John McCain contest to replace then-departing President George W. Bush. Bush had signed substantial tax cut packages in both 2001 and 2003, the provisions of which were mostly scheduled to “sunset” in 2010, during the term of the next president. Tax policy questions took center stage, with Senator McCain repeatedly labeling his opponent’s policies as “socialist”, and warning of skyrocketing tax rates during a potential Obama administration.
Ultimately, McCain’s accusations turned out to be mostly misplaced, as the vast majority of tax cuts survived—President Obama first extended the Bush tax cuts in 2010 (citing economic uncertainty), then helped make most of them permanent during the “fiscal cliff” negotiations of 2012. Per an analysis from the Center on Budget and Policy Priorities, an estimated 82% of the Bush tax cuts were in fact preserved by the Obama administration, despite the originally-scheduled sunset provisions. Preferential rates on capital gains income continued (for all but the highest income individuals), as did a substantial increase in the estate tax exemption threshold. In the final analysis, while spending patterns certainly changed under the Obama administration, taxes and revenues were largely unchanged, at least in percentage terms.
Now, 12 years later, a similar debate is raging between President Trump and his opponent, Joe Biden, who previously served as Vice President under Obama. In this case, the Trump-era tax cuts (mostly stemming from the TCJA) are at issue, many of which focused on corporate taxes, with some adjustments to personal rates (and exemptions) as well. Unlike in 2008, though, these cuts are not currently scheduled to sunset until the end of 2025, by which point we will have had another presidential election already. That certainly does not mean that changes to tax policy can’t (or won’t) take place in the next few years, especially if there is a change in Congressional control, but the “burning platform” that seemingly existed in 2008 is not present this time around. So, while broad, sweeping changes to tax policy are possible, recent election (and policy) history suggests that changes are more likely to be incremental, rather than widely transformative.
Potential areas of change
Indeed, the Biden tax plan (as it currently exists) mostly proposes a series of smaller tax hikes, focusing on a few “hot-button” areas—it would restore pre-TCJA tax rates (including capital gains rates) on the highest-income earners, while also limiting the Qualified Business Income (QBI) tax deduction, along with other potential changes to itemized deductions.
But the areas that are likely to draw the most attention—and have the most impact—relate to estate planning, and the tax treatment of inherited assets. Already, elected officials in both parties have signaled a willingness to allow increased taxes on bequests, as the 2019 SECURE Act featured a removal of the so-called “Stretch IRA”, which had previously allowed for a substantial deferral of tax recognition for non-spousal beneficiaries of IRAs and other inherited retirement accounts. It’s easier, it seems, to raise taxes on individuals once they are deceased than while they are still alive and living off of their own earned assets.
Perhaps noting this potential area of agreement between the parties, the Biden plan builds on the SECURE Act’s provisions by proposing similar tax increases on non-retirement (after-tax) investments. Under current law, inherited assets generally enjoy what is known as a “step-up” in cost basis upon the death of the original asset owner—instead of inheriting the cost basis (price paid) from the original owner, the inherited assets are treated as though they were purchased on the date of the decedent’s death, effectively erasing the transaction history on any inherited investments. While the “step-up” is certainly much easier from a record-keeping and reporting standpoint, it often means that capital gains that accumulated during the life of the decedent can, theoretically, completely escape capital gains tax. Given the recent strong advance in markets, many inherited assets have quite large embedded capital gains, making that “step-up” in basis quite valuable.
Under the Biden plan, the “step-up” would disappear, and many inherited assets would be subject to much higher taxes upon liquidation. When combined with a likely decrease in the estate tax exemption threshold, these tax changes could have substantial impacts on estate planning, gifting, and investing strategies, particularly for high-net-worth individuals.
Other potential impacts
Of course, tax law changes do not only impact individual tax returns, but the broader economy as well. If corporate tax hikes are considered, corporate profitability could suffer, putting pressure on stock market valuations. There could also be changes to retirement account deductions, which would have an impact on retirement savings strategies. With the outcome of the election still uncertain, it’s far too soon to know what tax policy will look like next year or beyond, but it’s never too soon to start planning.
Information found in this blog post is not intended to be individualized tax advice or legal advice. Please discuss such issues with a qualified tax advisor.
