Should You Accelerate Income in Anticipation of Tax Rate Increases?
- President-elect Biden ran on proposed increases of top tax rates.
- Tax rate increases may not occur until a later year (if at all), and may not affect you.
- Acceleration of income may not be appropriate in all circumstances.
- Your individual situation can help to determine if you should take action or wait and see.
Need help developing your personal tax strategy?
As part of his campaign, President-elect Biden proposed an increase of the top tax rates on personal income (from 37% to 39.6%), capital gains (from 20% to 39.6%), and corporate income (from 21% to 28%). In light of these proposed increases, taking proactive steps to accelerate your income into 2020 may be top of mind. Review the specifics of your situation with your tax advisor as you develop a strategy for year-end tax planning.
Rate increases may not occur until a later year
Tax rate increases in 2021 are possible, but are not a foregone conclusion. Both chambers of Congress must pass a tax bill before a president can sign it into law.
While Democrats retained the majority in the House of Representatives, control of the Senate will be decided by the outcome of two Georgia runoff elections on January 5. In order to achieve a 50/50 split (with two independents in their caucus), Democrats need to win both of these races. If a 50/50 Senate vote were to occur, Vice President Kamala Harris would cast the deciding vote. Significant tax law changes are far less likely if Republicans can retain control of the Senate with a victory in even one of the two Gerogia runoff elections.
However, even with Democratic control of the presidency and both chambers of Congress, tax legislation could be delayed in favor of other legislative priorities — such as combating the COVID-19 pandemic. Additionally, while the economy remains in recovery, politicians may be reluctant to enact tax increases, which could delay the effective date of rate increases until 2022 or later years.
Rate increases may not affect you
As you consider your own year-end tax plan, note that President-elect Biden’s tax proposals apply only to higher-income earners. The personal income rate increase applies to those who make more than $400,000, and the capital gains tax proposal applies to those who make more than $1 million. While any possible final tax bill is far from set in stone, individuals with income below these thresholds are at a much lower risk of tax rate increases.
You may be able to accelerate some income with hindsight
Review income acceleration strategies that require action (or non-action) by year-end. These include:
- The sale of appreciated securities
- Conversion of an IRA to a Roth IRA
- Delay of payments to vendors (for a cash method taxpayer)
Other income acceleration strategies can be implemented after year-end, but before the due date of the return. In these cases, consider a wait-and-see approach that may allow you to achieve some of the benefits of income acceleration at reduced risk.
Example: Alex sold the stock of his S corporation for $20 million in December 2020, with $4 million paid in cash at closing and the balance to be paid annually between 2021 and 2024. Alex had no basis in the stock at the time of the sale. Alex can either report a $20 million gain in 2020, or report $4 million in 2020 and the balance of the gain as he collects payments over time. If Alex extends his personal tax return, he would have until October 15, 2021, to decide which of these two approaches would be most advantageous.
Consult with your tax advisor to understand income acceleration techniques available to you, and which strategies — if any — require action by year-end.
Every situation is different
There is no one-size-fits-all approach to tax planning. To help determine the ideal strategy for your particular situation, consider individual factors, such as your:
- Current tax rates
- Anticipated future tax rates
- Tax rates in previous years
- Cost of capital
- Net operating losses
- Length of deferral period
Example: Walden Corporation is projected to break even for 2020 and expects to be subject to a 28% tax rate in 2021. With an opportunity to accelerate $250,000 of income into 2020 — given a 21% tax rate in 2020 — Walden can save $17,500 in tax, relative to paying tax on this income at higher rates in the future.
Walden then identifies additional opportunities to accelerate $300,000 of deductions into 2020, which will generate a $300,000 net operating loss. This loss can be carried back to offset tax paid in earlier years when Walden was subject to a 35% tax rate. Walden can thus save $21,000 in tax by accelerating deductions relative to using those deductions in future years.
While Walden would have saved money by accelerating income, it saved even more money by accelerating deductions.
Work with your tax advisor to develop a custom plan tailored to you, which may or may not include accelerating income into 2020.
How we can help
At CLA, we consider your specific situation to guide you through decisions and help you devise a personalized year-end tax plan that aligns with your objectives and available planning opportunities. We will monitor tax legislation in the coming months to help you understand significant developments and how they could affect you.