Elections Have Personal Income Tax Consequences
This is obviously another very complex topic but let’s try to cover the easiest scenarios and then share what we are thinking as the election draws closer and the end of 2020 is in sight.
Disclaimer: I am sure I got some of the facts wrong so I apologize in advance for that. Feel free to correct me.
What is clear is that whoever wins the November presidential election will have a monumental job – leading the country’s economic recovery after a global pandemic which has created unemployment rates which this country has not seen in 90 years. The expectation is that once the virus is contained, the economy will quickly recover, but whether or not that is really the case, remains to be seen. For our purposes today, we will assume this is indeed true!
Of course, we must remember that whether or not any of these scenarios actually comes to pass depends in large part on whether the president’s party also controls the legislative branch, as Congress does get a say in these policies. We won’t go down the rabbit hole on this part but just recognize that this fact certainly adds additional uncertainty. There are also definitely pundits out there who believe individual income taxes will increase regardless of election outcomes, due to the level of new federal debt which has been created this year alone.
Let’s start with the scenario that Trump retains the White House as this is the easiest scenario to play out even though the full plan is still being developed.
What may happen to individual income taxes, subject to Congressional support:
The 2017 individual income tax cuts may be extended, along with other provisions in the Tax Cuts and Jobs Act legislation, which also included an increased standard deduction and higher dependent tax credits. This Act is currently set to expire in 2025.
Q4 employee paid payroll taxes (primarily social security) which had been deferred until 2021 may be forgiven. There is also some talk of a permanent payroll tax cut.
Individual tax rates for middle class Americans might be reduced from 22% to 15%.
There is talk about reducing the long term capital gains rate (which is currently 0%, 15% or 20% depending on your income) or indexing it to inflation.
There are possible additions of tax credits tied to school choice or domestic travel.
Now let’s look at the scenario that Biden wins the White House.
What may happen to individual income taxes, subject to Congressional support:
The components of the Tax Cuts and Jobs Act would likely be rolled back, at least for high income earners. The income tax rate for Americans earning more than $400K would go from 37% to 39.6%.
Payroll taxes of 12.4% might be applied to earners on income over $400K, split between employers and employees. Today this tax is applied to income up to $137,700.
Dividends and long term capital gains might be taxed as ordinary income, at a rate of 39.6%, for incomes above $1 million. Today these dollars are taxed at 20% for this set of filers. Remember this does not impact IRA’s because your RMDs are already taxed at your full tax rate.
The step up cost basis for capital gains taxation might be eliminated as wealth is transferred to future generations.
Tax credits for child and dependent care, earned income, children and first time home-buyers might be added/increased.
Our thoughts (with lots of input from Bernie of Bernie’s Blog fame):
The election will hopefully be decided before the end of the year so we have time to execute some tasks, but now is the time to talk about what we might want to do….
Regardless of election outcome, a Roth Conversion is still a great strategy for those of you who have a traditional IRA and can free up some cash to pay the taxes in April 2021. As many of you know, a Roth conversion means that you convert pre-tax assets in your traditional IRA to post-tax assets in your Roth IRA. We can pick which assets to transfer so we can choose those which generate high capital gains/dividends and which may also be still recovering from the 2020 market downturn. Because these transferred assets are taxed at your full tax rate, this option is even better if Biden wins since tax rates for high income earners may increase. Many of you have already done a Roth conversion this year but there is no limit to how much you can convert, as long as you are willing to write the IRS a bigger check. If you want to do more, let’s talk about it.
If Biden wins, you have big gains in a taxable account, and you will need cash anyway in the next 12 to 18 months, we may want to sell some of those assets this year in case the capital gains tax rate increases from 15%/20% to your ordinary income tax rate. If Trump wins, capital gains taxes might go down, so there is no income tax reason to do this year, although we will do our usual end of the year re-balancing.
This has not been discussed yet, BUT dad believes that Biden may want to really limit Roth contributions in the future. He doesn’t believe that anyone will change the tax treatment of existing Roth accounts, but there is a possibility that the maximum income level will be reduced sufficiently that the tax benefit essentially disappears. So what that means is that if you can contribute to a Roth for 2020, you should be doing it because it might not be possible in the future. Remember that you have until April 2021 to make your 2020 Roth contribution but let us know if you want to do so we can ensure that the contribution gets assigned to the correct year.