Article:

TAXING US ELECTION ISSUES: RED CORNER VS BLUE CORNER

05 October 2020

In the US, the final countdown to the election has begun, although some may be speculating how soon after 3 November a winner will actually be established. Tackling the financial costs of the COVID-19 pandemic is high on the agenda.

In the US, economic experts are conjecturing that action will be required by either party in 2021 given overall debt levels are now over $27 trillion. What would a re-elected Republican party do and is there now a sharper focus on what a change of government to Democrat may mean?

A comparison of the Trump and Biden tax plans reflects quite a difference in economic policies. Should the Republicans retain either the White House or the Senate, based on the consistent comments that have been made to date, it appears there is little risk of significant change to the tax code. However if there is a Democrat clean sweep, there could be a considerable change in tax policy, targeting the wealthy and businesses to bridge the deficit between federal revenues and COVID-19 relief spending.

In this article we highlight the key policies that could affect US Private Client High Net Worth taxpayers. 

Republican Tax Plans

The Republicans have suggested that the 2017 tax cuts currently in place will be developed further, providing more rate reductions and removing the 31 December 2025 expiry date so they become permanent. 

Income Tax

We await Trump’s written policy but it is expected to confirm that the top individual income tax rate will become permanent at 37% and a slight cut in the middle-income tax rates would be offered.

The favourable rates that are applied to qualifying dividends and capital gains arising on assets held for more than one year are set to see a reduction from 20% to 15%. The desire being to promote investment to boost the economy.

An item that appears on both parties’ radars is the elimination of the beneficial carried interest treatment. Under current rules, carried interest (incentive profits that flow to the fund managers of a private investment fund), qualifies for the advantageous long term gains tax rate, once it has been held for at least three years. Trump may be about to do away with this provision, potentially leaving such income taxed at ordinary income rates.

With the 2017 Tax Cuts and Jobs Act (TCJA) becoming permanent under a second Trump administration, the exit tax charge currently applicable to certain individuals who expatriate, would also become permanent after 2025. 

Business Tax

It is expected that corporate tax rates would remain the same at 21% with no plans to reinstate any corporate Alternative Minimum Tax. 

Estate Tax

The 2017 TCJA gift and estate tax lifetime exemption levels are set to remain intact, indexed each year for inflation. 

Democrat Tax Plans

The prospect of a Democrat win, provided they have control of Congress as well, could see a return to pre-2018 tax rates and exemptions, among other policies to increase tax revenues. 

Income Tax 

The top individual income tax rate would be restored to 39.6% (from 37%) for taxpayers with income in excess of $400,000. Further, itemised deductions could be capped to 28% of income. 

The qualifying dividend and long term gains rates would be removed for taxpayers with income in excess of $1m, subjecting such income to effectively double the current 20% tax rate. Biden’s tax plan could also potentially see unrealised gains subjected to tax at death for certain assets (see comments below under Estate Tax). 

The favourable carried interest treatment would be eliminated and carry would be taxed at ordinary income rates. 

Biden has also focussed on the real estate industry, proposing to repeal certain loss claim entitlements, the deferral of capital gains under the like-kind exchange tax break, and certain accelerated depreciation on rental properties. 

Business Tax

Corporate tax rates are set to increase from the current 21% provisions to 28%. Further, the previous Alternative Minimum Tax provisions would be reinstated on profits exceeding $100m. 

Profits earned by foreign subsidiaries of US companies will also increase, with the current GILTI (Global Intangible Low Taxed Income) minimum tax rates set to double from an effective rate of 10.5% to 21%. 

Estate Tax

One of the most significant pieces included in Biden’s proposal is the reduction of the current $11.58m gift and estate tax exemption to the pre TCJA levels of $5m. 

Further, there is a proposal to remove the current step up in basis mechanism on inherited assets. This rule, which allows assets to pass to the next generation with a tax-free basis uplift, clearly preserves the value of estates being passed on. It is currently unclear whether this would lead to the taxation of unrealised capital gains on certain assets at death, or whether the capital gain would ‘carry over’ to the individual inheriting the asset. 

Other Taxes

Although Biden’s tax proposals are more measured than some of his Democrat presidential rivals, a new Democrat majority in Congress could push for higher taxes on higher earners, regardless of the fact that Biden has explicitly confirmed he, personally, does not support a wealth tax. 

Biden has also floated a potential social security payroll tax of 12.4%. The burden would be shared between employers and employees on earned income in excess of $400,000. 

Planning Opportunities

With the possibility of either party’s tax changes being applied from 1 January 2021, the window of opportunity for optimising individual tax affairs after the election could be small. Given the differences between the two plans, recommended actions under each scenario could be at opposite ends of the scale. 

Under Biden’s policies, standard year-end tax planning to reduce individual tax rates could be turned on its head. We could see gains being accelerated into 2020 to guarantee lower tax rates whilst pushing losses into a year with higher tax rates. Opt outs on instalment sales could also prove cost effective. Wealthy families may also consider completing substantive gifts before the end of the year to ensure the current gift and estate tax lifetime exemption is not wasted. 

In a topsy-turvy world, careful planning advice is more important than ever. It is therefore prudent to ensure prospective discussions with tax advisors and wealth managers are held sooner rather than later. 

If you have any questions regarding any of the above, please contact BDO’s Private Client US/UK Tax Team.

Summary policy comparison

Tax

Republican

Democrat

Top individual tax rate

37%

39.6%

Qualifying dividend and Long Term gains rate for high earners (Income > $1m)

15%

39.6%

Itemized Deductions

Maintain current provisions

Cap relief at 28%

Carried Interest held > 3 years

37%

39.6%

Corporate Tax Rates

21%

28%

Effective GILTI Tax Rate

10.5%

21%

Estate Tax

Continued tax free step up in basis on inherited assets; no gains assessed at death

Removal of tax free step up in basis on inherited assets; potential tax on capital gain assets at death

Lifetime Exemption

$11.58m

$5m


Sources:
http://www.crfb.org/papers/understanding-joe-bidens-2020-tax-plan
https://aboutbtax.com/R7C
https://www.usdebtclock.org/