man considering potential tax increases strategies

5 Strategies for High-Income Taxpayers to Consider in Preparation for Potential Tax Increases

Please note that this blog is based on laws effective in August 2020 and may not contain later amendments. Please contact Cray Kaiser for most recent information.

Have you considered that potential tax increases might be on the horizon? Regardless of who wins the elections this November, with rising deficits at the state and federal levels, government spending skyrocketing, and revenue dropping due to the COVID-19 pandemic, we can assume that taxes will go up in coming years. We can also assume that the likely focus for generating this additional tax revenue is the wealthy.

What Might the Potential Tax Increases Look Like?

Joe Biden, the presumptive Democratic nominee for President, has already said that the wealthy will be targeted within his tax plan. He has proposed the following changes:

  • Return the statutory tax rates to what they were before the 2017 tax reform enacted in the Tax Cuts and Jobs Act (TCJA). This means that for higher-income taxpayers, the top tax rate will increase from 37% to 39.6%.
  • Tax long-term capital gains and qualified dividends as ordinary income for taxpayers making over $1 million.
  • End the step-up in basis for inherited assets, which will result in increased taxes on beneficiaries when those assets are sold.
  • Phase out the Sec 199A pass-through deduction for households with taxable income in excess of $400,000.
  • Reinstate an overall limit (often referred to as the Pease limit) on itemized deductions. When itemized deductions are subject to the Pease limit, the itemized deductions begin to phase out when a taxpayer’s adjusted gross income (AGI) exceeds a threshold amount. In 2017, the last year the Pease limit was in effect, the phase-out threshold was $261,500 for single filers and $313,800 for married taxpayers filing jointly.  
  • Limit the tax benefit of itemized deductions to 28%.
  • Resume the 12.4% Social Security payroll tax once earnings reach $400,000. Currently, for 2020, this tax only applies to the first $137,700 of compensation. Employees pay half and their employers pay half; self-employed individuals also pay into this program. The amount subject to this tax is inflation-adjusted each year. If Biden’s plan were currently in effect, this payroll tax would apply for the first $137,700 of earnings and resume when a worker’s earnings reach $400,000, creating a gap between $137,700 and $400,000 in which this tax wouldn’t apply.    

How Can I Prepare?

If we prepare and plan for these changes taking effect in the near future, here are some strategies that higher-income taxpayers can consider implementing:

1. Sell appreciated stocks that have been held for over one year to take advantage of the lower capital gains rates in 2020 as a hedge against not qualifying for the capital gains rates in the future. If a taxpayer wants to maintain a position in the stock, it can always be repurchased immediately, since wash sale rules only apply to losses, not gains.  

2. Close the sale on your rental property or other real estate that you’ve owned for over a year in 2020. At this time, the top capital gains tax rate is 20%, so selling now is a hedge against the gain being subject to the proposed ordinary income rates of 39.6%.

3. Consider gifting money to family members and friends to utilize the current lifetime exemption and avoid the 40% estate tax. Although not mentioned by either presidential candidate, estate tax will be a likely target, and during the last election, the Democratic ticket proposed dropping the lifetime estate tax exclusion to $3 million. It is currently at $11.58 million ($23.16 million for couples).

4. Owners of private businesses should look for ways to accelerate income into 2020 and shift expenses to 2021 to avoid potentially higher income tax rates in 2021.

5. Relocate to a state with no income tax, if possible. As a result of the COVID-19 pandemic, many taxpayers have found they can do their work at home, and that shift in lifestyle combined with potentially higher state taxes has many people considering relocating to a state with no income tax.

If you would like assistance strategizing for potential tax increases, please contact Cray Kaiser. As always, the sooner you begin planning for taxes, the better.