The big question for 2021

The result of the presidential election is now clear but a nail-biter race in the U.S. Senate means control of the upper house likely won’t be decided until January 2021. That hasn’t stopped some tax lawyers, like Steven Loeb, from advising his clients to take some steps now before time runs out.

“It appears as though Joe Biden will be the next U.S. president, and his campaign policy recommendations involved increasing taxes on individuals who earn more than $400,000 a year,” said Loeb, a member of Chiesa Shahinian & Giantomasi PC who works in the law firm’s Corporate & Securities, Trusts & Estates and Tax groups. “He also floated an increase in the federal tax rate on capital gains, and a reduction in the amounts of the estate and gift tax exemptions.”

For the 2020 tax year, the lifetime estate and gift tax exemption is $11.58 million per individual, or $23.16 million for a married couple. The annual gift exclusion amount is $15,000. “Biden has talked about rolling back the estate tax exemption to $3.5 million,” warned Loeb. “So we’ve been advising clients who were thinking about transferring wealth anyway to consider making gifts and funding a trust before the end of 2020.”

Valuation issues could present a challenge for privately held businesses, he added. “If a taxpayer wants to transfer securities into a trust by Dec. 31, there are generally well-established valuation markers, like the stock market,” Loeb noted. “But closely held businesses usually need to be examined by a valuation expert, and that can take time. That’s why we advised clients during the summer to at least begin the process. This way, if they do decide to transfer business interests into a trust, they’re not bumping up against a deadline.”

Small-business owners are concerned about some possible tax law changes under a Biden administration, according to Alex Serrano, the New Jersey office managing partner at Citrin Cooperman, an accounting, tax and business advisory firm. “Business owners in the tristate area work hard to establish a viable business with significant employment, and some of Biden’s tax proposals could put a significant dent in their profits.”

One concern: removing the current Social Security cap of $137,700 for self-employed individuals. “Biden floated a kind of ‘doughnut hole’ where income of more than $137,700 to $400,000 would not be subject to Social Security tax — but then any income above $400,000 would be subject to Social Security tax, which is currently 12.4% for self-employed individuals. When you add up his proposed top federal income tax rate of 39.6%, the 12.4% FICA tax, Medicare tax at 2.9% and New Jersey’s top rate of 10.75%, you could be looking at a combined marginal rate of nearly 65.65%. This may mean we could see an increased outflow from the state, of individuals and businesses that provide jobs and economic activity.”

In addition to a proposed reduction in the estate tax exemption, Serrano said business owners could be hit by other tax revisions, including the elimination of the step-up in basis for inherited assets.

Accelerate gifting

Currently, when an asset — like securities, or a business interest — is passed on to a beneficiary, the value of the asset for tax purposes is generally readjusted to its market value at the time of inheritance, which can dramatically reduce the tax bite on a subsequent sale of the asset.

“Between the proposed rollback in the estate tax exemption, higher personal tax rates and an elimination of step-up in basis, the situation for business owners could be worrying,” Serrano said. “In some cases, we’re advising clients to accelerate their gifting and other estate planning activity so the transactions fall under existing law. But of course, our guidance is tailored to the individual’s specific situation.”

One entire industry segment, real estate development, may also be affected, he added, “under Biden’s plan to eliminate tax-deferred Section 1031 like-kind exchanges.” Section 1031 allows real estate investors and developers to swap certain pieces of qualified real estate for others without paying any federal income tax, even if the value of the property being swapped has significantly appreciated.

“If Section 1031 is eliminated, it could put the brakes on a lot of deals and disrupt commercial real estate development in New Jersey,” Serrano said. “Together, all of Biden’s tax proposals could push a drop in the general economy, and in the stock market. With so many New Jersey residents working on Wall Street, that could result in a double hit to the state. Fortunately, there is one silver lining to Biden’s tax plans: a first-time home buyer tax credit of up to $15,000 along with other increases to other credits benefiting low-income earners. That would be good news.”

Between the pandemic and a contested election, “it is difficult to predict what 2021 will look like,” according to Ryan DiPeri, tax supervisor at Bederson LLP, an accounting and advisory firm. “If a business has current losses in 2020 and expects more income in 2021, it may be beneficial to pull the income into 2020,” he said, since that may let a company use some or all of the loss to offset the 2021 income, instead of exposing it to a higher 2021 tax rate.

In addition, he noted, “[d]uring COVID, the CARES Act suspended the limitation on losses individuals were allowed to claim through 2020,” which is significant, because “many small businesses are pass-through entities or single-member LLCs,” where net profits and losses may be passed through to owners’ personal income tax returns.

Even without the change in administration, the clock may be running out on some valuable strategies, he added. “Currently, there is 100% bonus depreciation through 2022,” DiPeri said. “Starting in 2023, bonus depreciation begins to phase out, with 0% available beginning in 2027.”

Bonus depreciation, unlike Section 179 expensing, does not limit the loss a business can incur. “If a capital asset qualifies for bonus depreciation, and a business has the ability to make the purchase, it may make sense to purchase the asset in 2020 and generate a loss,” DiPeri said.

QBI deduction

Other issues also come into play. Sole proprietors and certain other business owners in New Jersey and elsewhere may get stung by Biden’s plan to phase out the qualified business income (QBI) deduction —also called Section 199A — which can allow eligible taxpayers to deduct up to 20 percent of their business income, cautioned Phil Drudy, managing director and tax practice leader for CBIZ MHM’s New York Tax Department.

Biden’s campaign discussed eliminating the QBI deductions for taxpayers with income over $400,000, “and that’s a big chunk of the New Jersey business market,” said Drudy. “But on the other hand, he’s also proposed tax credits and other programs that could be good for domestic manufacturers,” which could benefit some New Jersey businesses.

Still, the electoral uncertainty “Throws a kink into tax planning,” noted Daniel Mayo, a principal and national lead, federal tax policy at Withum, an advisory and accounting firm. “There’s generally no real downside to accelerating your [estate and other tax] planning but do it only if it makes sense anyway. Don’t let the tax tail wag the planning dog.”

Mayo said the firm is also seeing “more investor interest in Opportunity Zones [where investors may be eligible for capital gain tax incentives]. There hasn’t been much talk about eliminating OZs, but if the U.S. Senate turns blue, the regulations may be tightened so qualified projects may have to meet more-stringent requirements tied to affordable housing and job creation.”

Rutgers Law School Professor Michael A. Livingston also thinks a lot will depend on the U.S. Senate. “If Democrats gain control, then business taxes will likely go up, and the costs will be passed on to consumers. And individuals earning more than $400,000 a year can also expect to see their tax rates go up.”

But the ultra-wealthy may not, he added, since “They’re pretty good at shifting their income to [lower-cost] overseas jurisdictions.”

Biden has called out some of Trump’s tax policies as favoring the wealthy at the expense of middle- and lower-income individuals; but one that hit New Jersey residents in the wallet — the $10,000 cap on state and local tax deductions — may not be reversed so quickly, according to Livingston. “That’s an interesting example of a problem,” he noted. “You’d think they want to eliminate the SALT cap, but that could give a disproportionate tax break to the wealthy.”

In the midst of all the uncertainty, Livingston has some concrete advice for small- and medium-sized business owners: “It’s better to focus on your business and don’t stress about the taxes, unless you’ve got to decide on an impending transaction. Politics always goes back and forth, so the tax laws will likely always change. It’s better to spend your time on developing a long-term business plan.”