Publish Date

Dec 11, 2020

It’s Not Too Late… Critical Year-End Federal Tax Planning Questions That Should Be Asked Right Now

A&M Tax Advisor Weekly

Another Election Day is in the books, but as pandemic rages and the country deals with virtual schooling while anxiously waiting the Georgia runoff election, we thought it would be helpful to highlight some of the tax law changes that may occur during the next administration, and some actions that taxpayers may wish to take before year-end.  However, just as the solution differed depending on what school class was thinking about the issue, what a particular taxpayer should do is dependent on its specific facts, as there is no one-size-fits-all approach.

Effective Federal Income Tax Rates Are Probably Going to Increase

While in science class, one learns of gravity and Sir Isaac Newton’s “What goes up must come down,” however, when it comes to effective tax rates, it is more of an economics or accounting class concept. While the income tax rate reductions for individuals under TCJA are not set to expire until the end of 2025, many are anticipating that effective tax rates may increase sometime within the next few years.  There are several reasons for this view. First, over the past year Congress has passed several COVID-19 relief bills which have generated exorbitant debt. Thus, during the next Congress, “deficit hawks” will be seeking ways to reduce the ballooning deficit. Additionally, if the Republicans maintain control of the Senate, it is highly anticipated that they will enforce the application of PAYGO or “pay as you go” rule (which require that tax cuts and mandatory spending increases be offset by tax increases or cuts in mandatory spending) to most, if not all, of the bills originating in the Democratic House.  As a result, the Democrats will be seeking mechanisms to pay for their policy goals so that they can account for items in a revenue-neutral way. Tax rate increases will likely be on the table, as evidenced by some of President-elect Biden’s campaign proposals, including:

  • Increasing the individual tax rate for taxable incomes above $400,000,
  • Increasing Social Security payroll tax for wages above $400,000,
  • Taxing individual long-term capital gains and qualified dividends at ordinary income tax rates for individuals whose income exceeds $1 million,
  • Increasing the corporate income tax rate to 28%, and
  • Establishing a 15% corporate minimum tax based on book income for corporations with consolidated global profits of at least $100 million.

As a result, Republicans will need to determine whether they want to block all the Democrats’ policies, which is most likely, or allow Democrats to increase taxes and use those increases as a talking point in the next election. With that said, even if the Republicans choose to block tax increases, there are still two reasons to believe effective tax rates are going to increase. First, some of the TCJA provisions will expire over the next several years (e.g., immediate deductibility of research and experimentation expenses, further restriction on interest deductibility, and 100% first year bonus depreciation). Second, even without new legislation, a Biden Treasury can issue regulations that scale back benefits provided in existing regulations (e.g., the Global Intangible Low Taxed Income (GILTI) high tax exception and treating capitalized depreciation, amortization and depletion as expenses for section 163(j) business interest expense limitation purposes, but not for base erosion and anti-abuse tax (BEAT) purposes).

So, Federal Income Tax Rates Are Going to Go Up … Now What?

When taxpayers hear that tax rates are going up again, they traditionally either do The Rocky Horror Picture Show’s Time Warp or think of their environmental classes and recycle the concepts of accelerating income and deferring deductions, so income is taxed at a lower tax rate and deductions are taken against income that will be taxed at a higher rate.  However, because of the changes made by TCJA and the CARES Act, whether that approach would be truly beneficial is dependent on the taxpayer’s particular facts, including the applicability of the following provisions: