We hope everyone had a safe and healthy Thanksgiving holiday. Like many aspects of life in 2020, this Holiday Season will represent a massive change from typical tradition as the impact of COVID-19 continues. Combined with the potential for change after a Presidential election, the tax code has and could continue to experience immense change. Unlike the events of this year, taxes are more predictable and can be planned. The Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) and the potential for sweeping tax change create a number of tax planning opportunities to close out 2020 and for years to come.
Before we dive into the planning opportunities for the tax year 2020 and beyond, Detterbeck Wealth Management has also experienced change in the last month. That change is me, Danny Friedman. Coming from New Jersey, I have over four years of individual and corporate tax experience between KPMG, Andersen Tax, and Deloitte. When I am not studying a tax table or working on a financial plan, I am most likely watching the Scarlet Knights of Rutgers University. While earning my Bachelor of Science in Accounting at Rutgers, I was lucky enough to be on the student radio station where I traveled the country broadcasting Rutgers football and basketball games. After traveling to around a dozen states and twenty plus universities, I spent my first year out of college starting my tax career and passing all four parts of the CPA exam. I look forward to using my diverse background to help DWM clients effectively plan financial futures and become as tax efficient as possible.
Now back to tax. With the Holidays around the corner, charitable contributions are the best place to start. The CARES Act which was signed into law on March 27, 2020 allows individuals who don’t itemize their deductions to deduct up to $300 of cash contributions made in 2020. In other words, individuals who itemize their deductions will continue to deduct charitable contributions as before, but individuals who claim the standard deduction ($12,400 for single taxpayers/$24,800 for married filing jointly taxpayers) can now deduct, above the line, up to $300 of charitable contributions made in 2020. With an increased standard deduction starting in tax year 2018 because of the Tax Cuts and Jobs Act (“TCJA”), many taxpayers who previously itemized their deductions started to instead claim the larger standard deduction and no longer could deduct charitable contributions. With this in mind, we recommend taxpayers who take the standard deduction to submit receipts of their 2020 charitable contributions to their CPAs in order to deduct the contributions.
The most popular discussion in tax is how the tax code might change under president-elect Joe Biden. Potential tax reform would not affect tax year 2020 and may or may not impact 2021. Much of what Joe Biden will be able to do with the tax code will come down to the Senate election in Georgia on January 5, 2021. While it may be difficult for Joe Biden to pass any meaningful tax reform if the Republicans control the Senate, there are major planning implications on the line.
Joe Biden’s tax plan calls for the corporate tax rate to increase to 28% from 21% in the TCJA. While this would still be down from the 35% top rate in place during the Obama administration, the increased rate could motivate more start up business to form as a flow through entity. Entities taxed as a C corporation may also want to consider reorganizing into a flow through entity. After the TCJA and with a lower corporate rate, some start-up businesses formed as C corporations to take advantage of the 21% rate and to avoid income flowing through to partners at a potential individual rate of 37%. With a corporate rate back up to 28%, this makes the case for a start up to form or stay as a C corporation more difficult.
The other key highlight of his tax plan included increasing the top tax bracket from 37% to 39.6%. The increased rate would apply to married filing joint families with over $400,000 in taxable income. Regardless of the Senate election outcome in Georgia, taxpayers currently around this amount of taxable income might want to think about recognizing income in 2020 or 2021 and deferring expenses to later tax years. In other words, it may be a good idea to pay the taxes on income in 2020 or 2021 as the high income tax payer would likely have a higher rate after 2021. For example a taxpayer might want to recognize a short-term gain in 2021 that would otherwise be recognized as a short-term gain in 2022 as this is taxed as ordinary income and would be taxed at a 2% higher rate in 2022. Taxpayers owning a flow through entity or sole proprietorship, such as a rental property, may want to defer expenses and recognize large expenses later to offset income and a higher rate starting in 2022. It may be worth it to have your business undergo that rehabilitation process or technology change expense in a later year to offset the income flowing through as that income would be taxed at a higher rate.
Other key provisions Democrats may look to try to pass that would affect planning include a reduction in the estate-tax exemption, increasing the state and local state tax deduction (currently capped at $10,000) to reduce the tax burden for individuals in high tax states, and increasing incentives for child care and low-income earners.
At DWM, we do not prepare tax returns or know what tax legislation will end up getting passed, but we do provide tax projections and potential tax saving strategies and plans. We recommend reviewing your situation with your CPA before year-end every year to put yourself in the best possible financial situation. While 2020 has represented a change for all of us, you can count on DWM to help you to navigate through the financial uncertainty.
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