Post-Election Year-End Planning: What Financial Advisors And Tax Pros Are Advising Clients About Uncertain Tax Changes
The end of the year is a key time for financial and tax planning. The standard year-end-planning strategy is to defer income into the next year and accelerate deductions into the current year. But tax planning for year-end 2020 could change now that Joe Biden has won the presidency and Democrats may gain complete control of Congress. Biden's tax plan calls for tax increases on high earners.
However, the outlook for tax increases under President Biden is very uncertain. It depends largely on which party holds the majority of the US Senate, which will not be determined until the special runoff election for both of Georgia's US Senate spots in early January, after the end of the year-end-planning season. Even if Democrats do win Senate control to go along with their majority in the House of Representatives, many experts say tax-law changes are unlikely to be a focus of Biden’s first year.
Furthermore, in general you never want taxes to be the sole reason for making decisions with your equity comp and company shares. Nevertheless, some financial advisors and estate planners are still expecting higher taxes at some point under the Biden administration and would factor those into multi-year planning. What does all of this mean for year-end planning in 2020?
The Biden Tax Changes That Could Alter Year-End Planning
Among the different parts of Biden’s tax plan, these three would have an immediate impact on 2020 year-end planning:
1. The top rate of ordinary income tax would return to 39.6% from 37% for taxpayers with income over $400,000. What remains unclear is whether this income level would be different for couples (married filing jointly) and whether it’s $400,000 in adjusted gross income (i.e. before deductions) or in taxable income. If this tax hike seems likely to you in 2021 and you're concerned about higher tax rates, it would lead to accelerating income into 2020 where possible (e.g. exercise nonqualified stock options, receive cash bonuses before year end, do Roth IRA conversions).
2. Biden’s tax plan would raise the top rate of capital gains tax from 20% to 39.6% for individuals with over $1 million in yearly income. Capital gains and qualified dividends currently have a top tax rate of 20% (plus the 3.8% Medicare surtax). If this major increase in the top capital gains rate seemed likely to take effect in 2021, it could lead to capital gains harvesting before year-end to sell shares with substantial appreciation, paying tax at the lower capital gains rate, then potentially repurchasing the shares to reset the basis in them (see the FAQ on myStockOptions about this strategy).
Alert: Whenever you sell company stock, you must be careful not to commit insider trading, which is illegal. To prevent insider trading, your company may have blackout periods when you can't trade, often around the end of each calendar quarter, and window periods when you can. As part of any strategy involving stock sales, you need to know when these periods occur.
3. Biden’s tax plan would limit itemized deductions to 28% of value, with some deductions phasing out for income over $400,000. That would lead to also accelerating deductions, such as donations, into the current year for high-income taxpayers (the reverse of the usual approach when you expect higher taxes in the future) to maximize them before limits put into place. This concept is explained by financial advisor Jeffrey Levine in the Kitces.com blog.
Tax Changes Not Expected In 2021
In our review of client alerts and updates from wealth management, tax, and financial advisory firms of various sizes, we found they see little chance of taxes increasing in 2021:
Northern Trust: “We expect an agreement on some fiscal stimulus, while tax increases are off the table.... [T]he most likely outcome is divided government that will significantly limit policy.”
PwC: “A Republican-controlled Senate would largely eliminate the prospect of any significant tax increases until at least after the 2022 midterm elections. If Democrats do win an operational Senate majority with the tie-breaking vote of a Vice President Harris, the outlook for action on Biden’s tax plans could be put into question because of the challenges of operating in an evenly divided Senate.”
Grant Thornton: “While it is always possible that Democrats win both runoffs in Georgia and immediately pursue tax increases with Senate control, it would be surprising. Key Democrats have already indicated their first priority will be legislation battling COVID-19 and offering economic relief, and have signaled a reluctance to raise taxes while the economy is fragile. Taxpayers should exercise serious caution before using planning strategies that would accelerate income in anticipation of tax increases that appear increasingly unlikely to happen immediately.”
Manning & Napier (Fairport, NY): “Significant changes to tax policy are always difficult to pass, even in times of united, one-party control. Given current projections for a divided federal government, we believe the odds of tax reform have become even less likely. In our view, it is difficult to see how the varied political interests in Washington DC would be able to come together on a topic this controversial.”
Mark Mazur, the director of the Urban-Brookings Tax Policy Center and a former assistant secretary for tax policy at the US Treasury, predicts in an article at the website Law360 that President Biden will “punt” negotiations on Tax Cuts & Jobs Act provisions that expire at the end of 2025 into the next Congress. He thinks that Biden will instead focus on other priorities in his campaign platform. "There's no need to decide in 2021 what the tax code of 2026 will look like," Mazur told Law360.
Analysts from the Urban Institute recently updated their analysis of the Biden tax proposals. They do not foresee an effective date for new tax provisions any earlier than January 1, 2022.
The possible reasons for this delay are explained by John P. Barringer, Managing Partner of Executive Wealth Planning Partners in Denver, Colorado, in his myStockOptions article Stockbrokers' Secrets: Year-End Planning For NQSOs, Restricted Stock, And RSUs. “Even if the Democrats eventually gain control of three branches of the federal government, tax changes are not likely to be the first thing on their agenda,” he writes. “Over the last two years, the Democratic majority in the House of Representatives has passed hundreds of bills to address climate change, racial inequality, police reform, and voting rights. That stack of bills would be the first thing the Senate would want to review if party power changed.... So, with everything a new administration and Congress will have on their to-do list, regardless of the eventual outcome in each chamber, tax changes are unlikely to be addressed until at least 2022.”
What Financial Advisors, Tax Pros, And Lawyers Are Recommending
In its article, Grant Thornton says you should “be very cautious about rushing transactions or asset sales in ways that forfeit value, especially as immediate tax increases now look much less likely. Income and tax acceleration strategies should also be balanced against liquidity needs during this period of economic disruption, and only after considering the time value of money.”
Given the very low interest rates on money saved in the bank that you could apply to paying taxes, an article by CPA and financial advisor Craig Richards of Fiduciary Trust Company International raises the question of whether “it may be worth taking the chance” to accelerate income into this year if you are concerned about higher future taxes.
Jonathan Gassman, a CPA and the CEO/founder of accounting and wealth management firm Gassman Financial Group (New York), emphasized to me that financial planning is very client- and fact-specific. “The election results have not changed my multi-year planning,” he explained. “Our theme for most clients continues to be: accelerate income and accelerate charitable contributions of highly appreciated stock to get the deductions this year as they could be curtailed.”
He still thinks that taxes will be going up at some point, if not in 2021 then in the next few years. This view is shared by some of the other financial, tax, and legal advisors I reached out to. With this prediction in mind, multi-year planning with stock comp would focus on known dates for future restricted stock/RSU vesting and creating a strategy for when to exercise stock options.
Randy Joseph, a CPA with the tax-advisory firm Joseph & Hetrick (Seattle), also takes a multi-year-planning approach that goes beyond what tax rates might be in 2021. “We are cautiously discussing accelerating income and discussing the fact that no one knows what will happen. It’s such a crap shoot.”
Joseph M. Schmerling, a financial advisor and CPA with Schmerling Financial Group (Jenkintown, PA, and Silver Spring, MD), explained to me that year-end tax planning 2020 is different for many reasons. These include not just the tax proposals of President-Elect Joe Biden but also the impact of Covid-19.
“Our approach is to get ahead of disruptions by reviewing our clients plans and stress test the possible outcomes. Ultimately, we are looking for solutions that make sense even within the current fiscal environment,” he said. “We are not willing to derail the financial progress we’ve made on speculation.”
Estate And Gift Planning For Company Stock
The lifetime exemption amount for gift, estate, and generation-skipping transfer taxes increased in 2020 to $11.58 million per person ($23.16 million for married couples). Lauren Galbraith, an attorney with the law firm Farella Braun + Martel in California, explained in a pre-election article at myStockOptions that by making gifts now, you can lock in the current amount of the exemption, which may shrink in 2026 to about half those amounts—or perhaps even sooner, depending on voting results (see Estate Tax Planning For Large Company Stock Holdings: Four Tips For Using Record-High Lifetime Exemptions).
Now, after the election, she told me this change is probably not coming in 2021. “I do think that the urgency has fizzled and estate and gift tax changes effective retroactive to January 1, 2021, at this point seem highly improbable. Those who are on the margins in terms of whether they want to make significant gifts now may be best advised to hold off and take a wait-and-see approach.”
Bob Keepler, a CPA with the tax advisory firm Keebler & Associates (Green Bay, WI), calculates using basic probability a 25% chance (i.e. 50% x 50%) that the Democrats could take control of the Senate after the Georgia runoff elections. Rather than trying to “see through the fog,” his wealthy clients with substantial assets are going forward and still making gifts to reduce the size of their estates.
He believes that if tax changes do not happen in 2021, they may still occur after the mid-term elections in 2022, as 21 of the 34 Senators up for re-election are Republican. At the very least, he observes, the current tax laws will sunset at the end of 2025.