Tax Planning

Tax planning by accelerating the popularity of earnings by 2020 | Foley & Lardner LLP

As part of his campaign platform, Democratic presidential candidate Joe Biden has released a tax plan that can significantly increase capital gains tax. In particular, the platform includes a proposal to remove the preferred rate of 20% for long-term capital gains and qualified dividends for taxpayers with taxable income greater than $ 1 million. Instead, under the Biden Plan, that type of income would be taxed at normal income tax rates, with the highest ordinary income tax rate returning to the rate of 39.6% prevailing before the 2017 Tax Reduction and Employment Act, this proposal being adopted in wholesale. This would mean that capital gains subject to a 20% tax rate, if recognized in 2020, could potentially be almost double that tax rate in 2021 or 2022 (or later).

Here is an overview of the Biden proposals that affect high net worth individuals.

Our analysis of the likelihood that these rate increases will take effect on January 1, 2021 can be found here. Foley will host a post-election webinar with three former congressmen on November 10 to provide an insight into what the election result will mean for politics.

In general, effective tax planning requires that revenue recognition be deferred for as long as possible. However, in the event of tax increases, a taxpayer can save income tax by accelerating the income tax due and paying earlier but at a lower rate. Taxpayers should be cautious before accelerating income tax returns and measuring the potential opportunity cost of early tax payment. If the taxpayer pays tax earlier, they will not receive any investment income from funds used to pay the tax because the dollars used to pay the tax are no longer available for investment. The value of these opportunity costs depends on the time and the certainty of when the taxpayer would otherwise recognize and pay the tax, the tax rate in the later year, and the lost investment returns in the meantime. If a taxpayer records income that could otherwise be accrued for several years, the taxpayer may find that, under normal investment growth assumptions, the taxpayer is better off deferring the profit and paying income tax at a higher rate (this is because of the Capturing Profits) Now the tax must now be paid and the dollars used to pay the tax are no longer available for investment. Under some reasonable assumption, the breakeven point (between accelerating to 2020 and deferring the tax) for a dramatic increase in income rates is around 4 to 6 years. If interest rates rise only marginally, the breakeven point is around 2 years. If a credit event is very certain within three years, a taxpayer might consider hastening profits to a low tax year. These can be highly specific calculations.

If a taxpayer is interested in accelerating profits and paying personal income tax in 2020, there are a number of ways to capture profit:

  • For those taxpayers who own highly valued publicly traded stocks, the taxpayer can simply sell the stocks and then buy them back. The “wash sale” rule of Section 1091, which generally prohibits losses when a shareholder sells securities for a loss and repurchases the same or substantially identical stocks or securities, does not apply to the prohibition on recognized gains.
  • Taxpayers making installment sales in 2020 can opt out of the installment sales treatment (which captures all profit in 2020 rather than deferring them into the future).

    Taxpayers who sold a business and reported part of the purchase price as an installment sale in previous years can generally expedite the capture of capital gains from the hire purchase by either pledging the bond as collateral for a bank loan (which generally speeds up instant capture ) in the amount of the loan proceeds) or by selling, donating or exchanging the banknote. For example, taxpayers may consider giving or selling the Notes to a non-grantor trust, which would capture the profit.

  • For taxpayers with close business interests, with the expectation of selling such business interests in 2021 or 2022, there are a number of ways to capture profit at today’s rate of 20%, thus creating a basis on which to profit The sales proceeds can be offset in the future (which such income can be taxable at the tax rate of 39.6%):
    • Non-Grantor Trust:
      • If the taxpayer sells the stock or LLC shares to a non-grantor trust, the sale triggers income tax recognition. As soon as the shares or units are sold to the trust, the shares or units also receive a new basis in the amount of the purchase price. Section 267, which does not account for certain losses between related taxpayers, does not apply to the recognition of profits between related taxpayers. As a result, the sale to the non-grantor trust can generate a profit.
      • The trust, which may have limited liquidity, may purchase the shares on a notice. In this case, the taxpayer should choose installment sale treatment. The taxpayer receives the proceeds for the business interest only up to the sale price (the later sale price of a third party may be higher).
      • In addition to achieving the goal of accelerating profits, this type of transaction can also have estate tax benefits. The beneficiaries of the trust could be the grantee’s children. If properly structured, the difference in the selling price between what the taxpayer paid the trust and what the third party pays the trust for the stock in a future year would not be subject to inheritance tax upon the death of the grantor.
    • Self-Settled Trust: If the taxpayer wishes to retain more of the economic benefits of a stock or LLC interest even after a sale, the taxpayer can sell the stock or LLC interest to a self-settled trust. Through sales to resettled trusts, the grantor can be a beneficiary of the trust (and access the proceeds of the sale) while making a profit on the sale to the trust.
    • Conversion to LLC: S company owners can generate a profit by legally converting from corporation to LLC. Conversion to an LLC will result in a Liquidation / Recognition Event.
    • Finally, there are additional creative ways to trigger detection. For example, a taxpayer may look back at Section 721 (b) which makes a profit on financing a partnership that would otherwise be an investment company.
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