This article was updated October 29, 2020.
As the US presidential election draws near, tax issues will inevitably be a point of discussion. Also, the implications of the COVID-19 pandemic on federal and state budgets may also cause turbulence in tax policy. While it’s impossible to predict how the tax landscape may change, there’s some potential tax planning to consider in the meantime.
Now might be a good time to model how any potential changes or proposals could impact your business and personal finances to help you plan next steps. For example, if you think tax rates might increase or the market might fluctuate, there might be value in looking at how it could affect selling your business, real estate, or changing your entity structure.
There are other items to consider beyond taxes, but planning ahead in already disruptive times could be beneficial. Following are five considerations to explore.
1. Sale of Appreciated Assets
If you’re toying with the idea of selling a business, real estate, stock portfolio, or any other appreciated asset, now may be an opportune time to do so.
With large government deficits brought on by the economic shutdown due to COVID-19, there’s potential for increased federal and state tax rates in the future. In fact, several states, including California and New Jersey, have already proposed such tax rate increases.
Tax legislation takes time to pass at state and federal levels. Typically, changes are prospective rather than retroactive. As a result, this may provide a window of opportunity to sell appreciated assets at lower tax rates and secure some additional after-tax cash.
2. Entity Selection
With the passage of the Tax Cuts and Jobs Act in December 2017, the corporation tax rate was reduced from 35% to 21%.
At the time, this spurred a lot of discussion among business owners about the optimal tax structure for their business to be held in. Many owners of pass-through entities, such as a partnership or S corporation, questioned if they should convert to a C corporation.
While some changed course, most didn’t. If tax rates change again, business owners may want to take a fresh look at their choice of entity to determine if their current structure is still attractive. Note, however, there are many non-tax considerations involved when considering a change in operating structure.
3. Tax Rate Planning
In a constant tax rate environment, the goal is usually to defer income and accelerate deductions. However, if there’s an expectation that tax rates could increase in a subsequent year, this planning technique gets turned on its head.
In these situations, you could consider accelerating income to utilize lower rates today and defer deductions for a tax benefit in later years.
There are steps you can take to trigger income sooner:
- Sell appreciated stocks
- Convert a traditional IRA to a Roth IRA
- Accelerate the collection of receivables of a cash basis business
On the flip side, you can defer payment of expenses in a cash-basis business to a subsequent year. You can also delay depreciation deductions by making investments in fixed assets, such as computers and equipment, and by paying bonuses in January versus December.
4. Estate and Gift Tax
The current lifetime estate tax exemption amount for an individual is approximately $11.6 million ($23.2 million for a married couple). This is the highest the exemption amount has ever been and represents the amount you can give to your heirs without gift tax. This exemption amount is scheduled to expire at the end of 2025 by law but could decrease sooner if political winds shift.
If you’ve considered transferring wealth to your heirs—whether it’s ownership in a business, stock, or real estate—now may a good time to do so for two reasons:
- If you use up your lifetime exemption now, there’s no clawback or penalty if the amount is lowered in the future.
- Due to COVID-19, the value of many assets have decreased, allowing more to be gifted.
Estate tax planning can provide significant tax benefits to a family. It also takes time, so starting the process sooner rather than later is critical.
5. Basis Step-Up
Under current law, the step-up in basis rule reduces the heir’s taxes when they sell assets they’ve inherited. When an individual dies, the tax basis of an asset gets stepped-up to the fair market value at the date of death. This allows the heir to sell the asset the next day at no gain.
If the step-up in basis rule is modified or eliminated, a taxpayer may want to consider transferring assets to a trust or similar vehicle to cap the value of the asset in the donor’s estate and allow future appreciation to occur outside of the estate.
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For more insight on planning considerations, contact your Moss Adams professional.