By now, many of us have grown weary and a bit confused by reports of possible tax reform scenarios first outlined by the Biden Administration during the presidential campaign and confirmed in the Green Book released by the Treasury Department this past spring. More recently, these tax reform scenarios were modified in proposals announced by the House Ways and Means Committee. Favorable vote margins are slim in both the House and the Senate, and there is uncertainty as to when the legislative process will be finalized and in what precise form it will finally take shape.
The annual process for tax planning typically heats up in November and December. Given the prospects for potential tax law changes, now is a good time to begin assessing how you and your business can be better equipped for a new tax environment largely beginning in 2022, but in some important respects in 2021. It is imperative to prepare for what is coming as soon as possible.
Among the many proposed changes is an increase to both the corporate and individual tax rates. For individuals, the top marginal rate could be raised to 39.6 percent from the previous top rate of 37 percent. A new surtax of 3 percent could apply to modified adjusted gross income in excess of $5 million ($2.5 million for married filing separately).
For corporations, the proposed rate changes would be graduated, with a top bracket of 26.5 percent, a 5.5 percentage point increase from the previous flat rate of 21 percent. The rate changes would take effect for tax years beginning after December 31, 2021.
If the proposed increases in tax rates are enacted, a wise income tax planning strategy would be to look for ways to accelerate income into the current period and to defer deductions into the subsequent period, wherever possible.
Depending on your tax accounting method, there are various techniques that can accelerate income recognition into 2021, many of which are the opposite of traditional tax planning approaches aimed at deferring recognition to the next year. Your tax advisor can assist you with the appropriate approach for your particular circumstances. Care should be exercised so as to not achieve a tax planning objective of accelerating revenue recognition only to suffer an offsetting loss of an otherwise available benefit such as the employee retention tax credit. On a personal level, if you were weighing making a Roth IRA conversion from a traditional IRA, it may make sense to do so before year end to capitalize on the lower top marginal rate currently available.
As to delaying tax deductions to next year when tax rates will likely be higher, consider holding off on placing a large equipment addition into service, delaying into the first quarter of 2022. The depreciation write-off could be of greater economic value next year. There are also tax planning opportunities if you do not defer placing an asset in service. Also, consider whether 100 percent bonus depreciation or regular MACRS depreciation can be made during tax return preparation. This would allow time for the tax legislation and 2021 income to be more certain. Deferring any large charitable contributions to 2022 is another possibility.
There are also significant changes involving estate tax provisions which have earlier potential effective dates than the corporate and individual income tax rate changes. In particular, transfers to grantor trusts – a commonly-used estate planning technique – that take place after the date of enactment will no longer qualify for favorable treatment. A sale to a grantor trust, currently treated as a nontaxable event for income tax purposes, would become taxable for a gain but nondeductible for a loss. Transfers to a grantor trust prior to the effective date of changes would be grandfathered, representing a good reason to be review your estate and possibly update your estate plan options as soon as possible.
The above suggestions are just a few examples of strategies that may be beneficial in the event that the proposed tax increases make their way into law. Please consult your tax advisor as year-end approaches to discuss options and put a plan into place.