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As part of his campaign platform, Democratic Presidential nominee Joe Biden has released a tax plan which may significantly increase the capital gain tax. Specifically, the platform includes a proposal to eliminate the preferred 20% rate on long-term capital gain and qualified dividends for taxpayers with more than $1 million in taxable income. Instead, under the Biden plan, this type of income would be subject to tax at ordinary income tax rates, with the highest bracket ordinary income tax rate returning to the 39.6% rate in effect prior to the Tax Cuts and Jobs Act of 2017. If this proposal is adopted wholesale, it would mean that capital gains subject to a 20% tax rate if recognized in 2020, could perhaps be subject to nearly double that tax rate in 2021 or 2022 (or later).
See here for an outline of the Biden proposals affecting high net worth individuals.
For our analysis of the likelihood of whether these rate increases occur effective to January 1, 2021, see here. Foley will host a post-election webinar on November 10th with three former Congressman to provide some insight as to what the election outcome will mean for policy.
Generally, effective tax planning calls for deferring the recognition of income for the longest possible period. However, in the case of tax rate increases, a taxpayer may save income tax by accelerating income tax due and paying sooner but at a lower rate. Taxpayers should be cautious before accelerating income tax gain and measure the potential opportunity cost of paying tax early. By paying tax earlier, the taxpayer will not have the investment returns from funds used to pay the tax because the dollars used to pay the tax are no longer available for investment. The value of this opportunity cost depends on the amount of time, and certainty, of when the taxpayer would otherwise recognize and pay the tax, the rate of tax in the later year, and the investment returns forgone in the interim period. If a taxpayer recognizes income that could otherwise be deferred for several years, the taxpayer may find that under usual assumptions of investment growth, the taxpayer would be better off deferring the gain and paying the income tax at a higher rate (this is because recognizing gain now requires that the tax is paid now and dollars used to pay the tax are no longer available for investment). Given some reasonable assumptions, if income rates go up dramatically, the break-even point (between acceleration into 2020 and deferring the tax) is about 4-6 years. If rates go up only modestly, the break-even point is about 2 years. If a recognition event is highly certain within three years, a taxpayer might consider accelerating the gain into a low rate year. These can be highly specific calculations.
If a taxpayer is interested in accelerating the gain and paying the income tax in 2020, there are a number of ways to cause the recognition of gain:
Taxpayers who sold a company and reported part of the purchase price as an installment sale in prior years can generally accelerate the recognition of the capital gain on the installment sale by either pledging the note as security for a bank loan (which generally accelerates immediate recognition up to the amount of loan proceeds), or by selling, gifting, or exchanging the note. For example, taxpayers may consider gifting or selling the notes to a non-grantor trust, which would cause the gain to be recognized.