While no one can predict with certainty what post-election tax changes lie ahead, savvy private business owners and individuals recognize that modeling out different scenarios is a prudent exercise as the 2020 tax year comes to a close.
A weakened economy, persistent low interest rates and state and federal fiscal challenges are just a few of the factors that may impact taxes in the months ahead. Recognizing how each of these may affect your current business and personal income tax position — as well as your estate and gift tax planning — may allow you to balance risks of the unknown against the certainty of your comprehensive tax, wealth management and philanthropic strategies.
While the US election outcome faces legal actions in several states, and control of the Senate is still undecided, businesses are nonetheless looking ahead to January when the 117th Congress will convene to certify the election results and likely put Democrat Joe Biden on course to take the oath on Inauguration Day. As explored in our prior insight, the Biden administration has laid out a tax proposal that may have a significant impact on corporate and individual income taxation. Assuming current election results are certified, the outlook for action on Biden administration tax proposals will depend on control of the Senate, since Democrats have retained control of the House.
If the Republican party maintains control of the Senate, which will be determined in January’s Georgia runoffs for two seats currently held by GOP senators, significant tax increases appear unlikely. However, if the Democrats assume a 50-50 majority and gain Senate control with the tie-breaking vote of the Vice President, figuring out where tax policy may land in the new Biden administration’s priorities should be considered. History would tell us that retroactive tax changes are unlikely but not impossible, so you should understand the possible impact of Biden’s proposals on your current tax liabilities and planning structures.
In assessing the likelihood of significant changes, it’s important to understand the procedures for passing legislation in the Senate. Legislation generally requires a 60-vote majority to pass in the Senate, but tax increase legislation could be passed with a simple majority in the Senate using the “reconciliation” process. In a 50-50 Senate, however, the Democrats would have to be unanimous with a Vice President Harris’ tie-breaking vote. In other words, any tax increase proposal would need the support of the most conservative Democratic senators.
Most importantly, one of Biden’s most significant tax increase proposals — to assess Social Security tax on individuals earning more than $400,000 — falls outside the scope of budget reconciliation procedures. This proposal would amount to a 12.4% tax increase. Current law specifically prohibits changes to Social Security through budget reconciliation procedures. Overcoming the general 60-vote threshold required to pass Senate legislation would require Democrats to eliminate the ability of Senators to filibuster legislation. This appears unlikely since at least one Democratic senator, Joe Manchin of West Virginia, has already expressed opposition to changing the Senate filibuster rule.
While the two parties are generally divided on the subject of tax increases, there may be some opportunities for bipartisan tax legislation in 2021. Both parties have expressed support for using tax incentives to encourage the onshoring of US manufacturing and jobs. In evaluating strategy around supply chain changes or potential expansion, this trend is important to understand from a US federal and state tax perspective. There also could be bipartisan support for addressing certain tax provisions that are set to change in 2022, such as rules governing R&D expensing and interest expense limitations.
How much tax savings may be available by shifting your residency or moving your business to a lower tax state? Can you simply spend more than half a year at your home in Florida to eliminate your state income tax liabilities? What other states have considered increasing their business or individual income taxes? Understanding the tax impact of different scenarios and knowing the steps that need to be taken to effectively and completely change your residence is a conversation that should occur with your tax advisor.
In September, New Jersey enacted a new millionaire’s tax. Illinois’ Allow for Graduated Income Tax Amendment ballot initiative, which would have significantly increased certain tax liabilities, failed in the general election. Arizona voters, however, passed Proposition 208, the Invest in Education Act, which will impose a 3.5% tax surcharge on taxable annual income over $500,000 for married persons filing jointly. And Massachusetts voters next year may enact their own millionaire’s tax.
The trend to introduce tax rate changes and the limitation on the deductibility of state taxes paid, which was enacted with the 2017 federal tax reform, have caused many higher income individuals to move to states with lower income taxes. But making such a move without understanding the whole picture may result in a logistical headache and an increased state tax liability.
Many states have also reacted to the US Supreme Court decision, South Dakota v. Wayfair, and are anticipating a broadening of the taxation standard for businesses, which has resulted in economic nexus proposals and changes to how business income is apportioned to states. This may become more significant in light of a remote workforce possibly becoming more permanent. Additionally, while states are actively offering income, payroll, sales and other tax incentives to jumpstart economic recovery, they are keeping a close watch to make sure negotiated criteria is met, when appropriate. Considering how these factors impact state tax liabilities is even more complicated in a flow-through business as the partners’ state of residence influences the analysis. Understanding how these components affect your overall state obligation should be critical in planning for change.
Given the low interest rates that are now available, individuals and businesses should examine existing financing structures and agreements or look to incorporate them into their dividend or wealth planning strategies. Intrafamily loans, grantor retained annuity trusts (GRATs) and sales to grantor trusts, as well as charitable giving through a charitable lead annuity trust (CLAT) may provide a more beneficial tax result than found with previously higher rates.
Additionally, the debt of a taxpayer who refinanced a mortgage that was taken out on or before to December 15, 2017, is considered grandfathered and the new loan is still subject to the pre-2017 federal tax reform interest deduction limit on $1 million mortgages for joint filers.
As the end of the 2020 tax year approaches, businesses and individuals should carefully examine what actions should be taken before December 31 to take advantage of known tax opportunities and those that might change with the Georgia runoff results. Year-end conversations should be scheduled to discuss these and other year-end actions, and these conversations should allow sufficient time to make any necessary changes or complete intended transactions.
For more on the top policy issues at play and their business impact, check out our Election 2020 homepage.
Private Company Services Tax Leader, PwC US
Personal Financial Services Leader, PwC US
Irene C. Estrada
Managing Director, Private Company Services, PwC US