I Don’t Know and Neither Do You…
On November 5th we will all head to the polls At stake is control of the Federal government for at least the next two years. Hopefully, on November 6th we will know the results.
From a Tax and Financial Planning standpoint there are only 3 possible outcomes. One party controls both the House and Senate and wins the White House (that’s 2), or we get split government. The outcome will create many predictable events, laws and policies that are likely to affect the Financial Planning of almost everyone.
Before I break down the different paths, I want to share some facts that are important to know.
First, the individual portion of the 2017 Tax Cut & Jobs Act (TCJA) will expire on 12/31/25. This means for 2026 the individual portion of the tax code will revert to the Obama era tax code. Included in this are higher tax rates, lower estate and gift tax exemptions, higher capital gain taxation, and the elimination of section 199A – Pass through deduction for small business owners to name a few biggies.
The party controlling the Senate will only need a simple majority to pass budget items (taxation and spending), unlike the usual 60 votes for almost all other legislation.
Regardless of who the winner is, there will always be some horse trading on minor items at the margin, those bi-partisan issues that they find some agreement on.
Now let’s take a look at the 3 possible scenarios and possible strategies:
A Republican Red Sweep.
- The TCJA will be extended and made permanent. I will guess pretty much as is.
- The SALT deduction limitation may be amended, as it is not popular with Republican legislators from Blue states.
- Tips and Social Security earnings may become tax free.
- There may be some move to shore up Social Security, but through raising the retirement age (down the road), rather than through higher taxation.
- Because changes are likely to be minor, most people will not have much planning to do in anticipation of tax code reform. It is important to remember that personal income tax rates are not likely to decrease from these levels and will still have a future risk of going up from here.
Split Government.
- The TCJA will expire and higher tax rates will go into effect for individuals and pass though small businesses for 2026.
- It is not likely that there will be much modification to the reversion other than the aforementioned horse trading. There could be some trade-offs between taxation and spending as well.
- As tax rates will be going up, there are some general strategies that could benefit many people although because everyone is different there may be tradeoffs for some.
- You will have two tax years (24 & 25) to plan implement these strategies. That is an advantage allowing income acceleration to be spread out avoiding tax bracket creep.
- Some specifics:
- Accelerate ordinary income where possible. Paying taxes at a lower rate will usually be worth more than the time value savings of deferral.
- Consider recognizing capital gains while the rates are lower. From a tax perspective, it may be time to sell your business or other assets such as highly appreciated stocks or investment real estate. Exercise stock options.
- Convert your traditional IRAs to Roth’s. Change your 401(k) contributions to a Roth.
- If you have assets in the $12 Million+ range, you might consider gifting some of them while you can take advantage of the higher gift tax exclusion. You might also consider selling the assets, paying the lower cap gains rates and gifting the cash, so your heirs don’t have to pay higher rates at a future date.
- Defer losses. They will be worth more when rates are higher.
- Defer charitable donations. They will be worth more when rates are higher.
- Analyze whether it may be prudent to convert your closely held pass through business to a C Corporation which will pay tax at 21%, in light of the expiration of the QBI.
A Democratic Blue Sweep.
- The Democrats would likely attempt to raise taxes beyond the pre-2018 Obama rates.
- Some of their proposals include:
- Increasing the Medicare surtax from 3.8% to 5%.
- Eliminating the cap on Social Security taxes (FICA).
- Eliminating or capping the step up in basis on inherited assets.
- Taxing some capital gains as ordinary income.
- Unlike the other two scenarios, raising corporate taxes as well.
- The strategies would be largely the same as under split government, but even more critical for many taxpayers.
It’s important to remember that today anything is possible. On November 6th, we will have a good idea about what is probable.
The Bottom Line: On November 6th, we will all know.
–Michael Ross, CFP®