With just six weeks left before Joe Biden’s inauguration, businesses are preparing for a number of tax issues that will arise before and after January 20, 2021. In this episode, Jackson Walker Tax partner Nate Smithson discusses some anticipated changes and what businesses should be doing right now.
Greg Lambert: Hi, everyone. I’m Greg Lambert, it’s December 7th, and this is Jackson Walker Fast Takes. We now have less than 50 days until the inauguration of Joe Biden for president of the United States. One of the biggest issues that businesses are planning at the moment is what changes in their tax planning should they consider before the end of 2020? What happens if there’s a Republican or Democratic Senate after January 5, 2021, and what President-elect Biden’s tax policy means for them in 2021? I asked Jackson Walker Tax partner Nate Smithson to come on the show to talk about these issues.
Nate, thanks for taking the time to be on the show.
Nate Smithson: Thanks for having me.
Greg Lambert: So, let’s begin with the big question: What does a President Biden tax policy mean for businesses?
Nate Smithson: Well, that’s really the million-dollar question, or in this case, the $400,000 question. But, you know, the big thing to consider is that tax rates are unlikely to go down, but they could go up, and that really is dependent on certain things happening. First, there’s the Senate race in Georgia, where it would take both Democratic candidates winning those seats in Georgia. It would also take cooperation, because there are still 50 Republican senators. So, getting anything done would take, you know, it would certainly take everybody being on board. And then finally, it’d really be an appetite for tax increases and the economic recovery following the pandemic. So, there’s a load of issues that go into it. And within that, you have to think about when these—any tax changes—would be effective. One of the big original concerns was, potentially, they might be effective as of January 1, 2021. They could also be effective as of their—the date that they’re enacted, or it could even be pushed to 2022 at the point in time that we are in a true economic recovery.
Greg Lambert: So with the Biden tax policy, who would be impacted by the changes?
Nate Smithson: One of the big ones would be corporations. Just for basics, corporations are subject to two levels of tax at the corporate level, and then also when there’s a distribution out to shareholders. Under the Tax Cuts and Jobs Act, the corporate rate was actually dropped from 35% to 21%. There was an elimination of the corporate alternative minimum tax, and that really had the effect of when you look at the blended tax rate, it dropped it pretty close to 37% for the individual paying the top rate, which is down from about 52%. And so that was a significant drop in the tax rate. Based on the information that has come out from President-elect Biden, he would seek to increase the corporate tax rate to 28%, and then add on a 15% corporate minimum tax. To the extent you’ve got a large corporation—so, effectively book income in excess of $100 million—that would drag up that blended rate to a 42% top for the top-rate individuals, depending – and we’ll talk about this in a minute – but if the capital gains rate goes away for high-income taxpayers, that blended rate could get up to 55%, which is even above or beyond where it started from. So beyond corporations, you’re looking also at other types of entities like partnerships, S corporations, sole proprietorships, those are all pass-through entities and so they don’t themselves pay federal income tax. Instead, a taxable income is allocated up to the partners or shareholders. So under the Tax Cuts and Jobs Act, the tax rate for individuals was dropped across the board. The highest rate had been 39.6%, and it dropped to 37%. There was also a larger step into those rates. These are already set to expire in 2026, but it is possible that we might see a increase at the top rate back to 39.6% for those in the top bracket. And this would really affect individuals that have more than $400,000 in taxable income. And that’s kind of a leading indicator across the board, the $400,000 mark, because it is viewed as separating high-income individuals from everybody else.
Greg Lambert: So what about those capital gains rates?
Nate Smithson: Capital gains rates – those are also a big question mark. Right now, the top capital gains rate is 20%—23.8% if you’re including the net investment income tax. There is a proposal to eliminate that 20% rate for taxpayers with annual income over $1 million. So, they would be paying at the top rate, which is currently 37%, but could be sliding up to 39.6% under a Biden tax plan.
Greg Lambert: So Nate, are we likely to see a wholesale gutting of the Tax Cuts and Jobs Act that was enacted under the Trump administration?
Nate Smithson: So, the Tax Cuts and Jobs Act was enacted in 2017. Early on in Biden’s campaign, he expressed support for the repeal of the Tax Cuts and Jobs Act. However, at this point in time, it seems unlikely that there’s going to be a wholesale gutting of that act. And really, the intention is to impact those individuals who are making more than $400,000 annually. And so there are certain things that are likely to be safe, like the 100% bonus depreciation, certainly not guaranteed but likelihood, especially because it is going to be phased out over a period of years. There’s also carried interest considerations. The Tax Cuts and Jobs Act was the first material intention to impact the what’s called a carried interest, which is really an interest that’s available for service providers to partnerships. You hear about it a lot in private equity and hedge funds. But the intention was to cause any of those dollars to be taxed at short-term capital gains rates rather than long-term capital gains rates. There’s a possibility that there could be further changes there. There’s also the qualified business income deduction that was put forth with respect to pass-through entities. And although that’s also likely safe, there could be some changes with respect to the phase outs involved in that.
Greg Lambert: One of the things that many of us worry about are the employment or the Social Security taxes. Any changes coming in either of those?
Nate Smithson: So currently, the rate on Social Security taxes is 12.4% for individuals, and usually that is split between employer and employee. Further, that is subject to a cap. And so right now the cap is $137,700. The proposal is that for those people who are making more than $400,000 annually, that they would again be subject to the Social Security tax once they achieve that $400,000 threshold. This is called the doughnut hole, meaning that you pay taxes on both sides of it, but it only applies for those people that are making $400,000.
Greg Lambert: So Nate, with the uncertainty around tax rates in 2021 and beyond, is there anything taxpayers can be doing right now?
Nate Smithson: Certainly. Although it’s murky, there’s certainly the specter of tax changes that are going to be retroactive to January 1, 2021. And so this is going to impact two parties really. One is the person who has a potential for a lot of capital gain in 2021 or beyond, and the other is the person who is starting up their business and wondering which form they should be using. For the person with capital gains, they should really talk to their tax advisor and just see if there’s anything that can or should be done as far as recognizing those capital gains in 2020 rather than 2021. Because although there’s no certainty that the rate is going to change, it does provide some benefit to at least know that the rate won’t be changing for 2020 itself. As for the person who is starting their own business, they should also talk to the tax advisor. There’s obviously many differences that could come into play, but they should certainly get some advice in advance before they choose any form of business, just based on what might happen in this coming legislative session.
Greg Lambert: Well, Nate Smithson, thank you very much for taking the time to talk with us.
Nate Smithson: Thank you.
The music is by Eve Searls.
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