Tax Implications of US Election Results

Tax Implications of US Election Results

October 16, 2020

Host: Hello and welcome to Talking Markets: exclusive and unique insights from Franklin Templeton.

Ahead on this episode: breaking down the tax implications of US election results. We’ll hear how various outcomes could impact income, investments and retirement plans…and what you may want to consider right now, even before the election happens.

Craig Richards, Managing Director and Director of Tax Services at Fiduciary Trust Company International, joins Stephen Dover, Head of Equities at Franklin Templeton for this conversation.


Stephen Dover: Welcome Craig.

Craig Richards: Thank you, Steven.

Stephen Dover: Craig, one of the proposed changes with the Democratic platform is that the top ordinary income tax rates would change from the current 37% to 39.6% for incomes over $400,000 a year as I understand it.

Craig Richards: If these changes do come into place, what we might see is what's currently in place is a 37% top tax bracket, and that's for folks that are married and they're making an excess of $622,000 of taxable income or single folks making more than $518,000 dollars worth of income. And essentially what we think would happen is the current top rate of 37% would be increased to 39.6. It would effectively go back to what we had prior to 2018 before the Tax Cuts and Jobs Act was implemented.

Stephen Dover: Craig, how might these changes in personal income tax rates affect investors?

Craig Richards: I think for investors whose source of income is qualified dividends, long-term capital gains, depending upon what tax bracket they're in, will effectively tell us what changes there'll be for them. Vice President Biden has gone on record in saying there will be no tax increases for anybody that makes up to $400,000 of income. So that's in line with where we are right now, as far as current long-term capital gain and qualified dividend rules. So that top bracket right now, it starts right now for if you're single, $441,000, if you're married, filing joint, $496,000. So, we think that folks underneath that threshold would still continue to keep paying at the current rates. We think that the folks that would be affected would be the folks that would be making above $1,000,000 dollars. So, for investors that are beneath that $1,000,000 threshold, we don't think there'll be changes at all. But for folks who are above that, there is absolutely changes. Same thing for folks that have ordinary income, so short term capital gains, interest, wages—those folks will be taxed potentially at a higher rate, but again, only if they're in that top bracket, that top bracket right now, which is 37%. If you're underneath the $400,000 threshold, you'll still continue to be taxed at rates that you've currently experienced. But if you're above that, that's where you might get hit with this new 39.6 top rate.

Stephen Dover: Craig, another proposal is the elimination of the step-up basis or the estate tax. Can you explain that and what the implications of that are?

Craig Richards: Stephen, under current tax law, when a taxpayer dies with an appreciated security or appreciated property of any kind, at their death, they get a step up to date of death value. So, let's just say if somebody bought a security of $50 and when they died it was worth $100, the cost basis gets stepped up from 50 to 100. There's this potential that in a new tax regime, that that step up would be taken away without having to pay, at your death, a tax on the unrealized gain. So if that's the case, now what happens is if I have an unrealized gain in my portfolio, I might decide that I'm going to hold onto that position, not sell it during my lifetime, because my beneficiaries of my estate will get this step up in value at my death, and then they'll sell it and not have to pay any capital gains tax. If that is no longer the case, then I think folks will be less inclined to hold on securities for a longer term, longer period of time. And they'll be more willing to put them back into the market and sell them, during their lifetime, knowing that there's no incentive to hold on and get a free step up in tax basis at their death. So, I think we absolutely could see changes there, in the reaction that people have without having this free step up that we currently have in the current tax environment.

Stephen Dover: Craig, of course we don't know how the elections are going to turn out. What changes might we see on a Republican administration?

Craig Richards: Yeah, so we don't believe that we'd see very many changes at all under Republican administration. You know, the Tax Cuts and Jobs Act was signed in December of 2017. It became law in 2018. And right now, that's the law that we have on the books through 2025. So those changes that were put into a place back in 2018, we believe under a further Republican administration that’s what we would have. I think one of the only changes that has been talked about—President Trump talked about this a few weeks ago—he had alluded to the fact that he would be interested in further reducing long-term capital gain rates down to 15%. Other than that, I think that the changes that were in effect are essentially what we would see for another four years.

Stephen Dover: So, one of the proposals are a change in the so-called SALT tax, which is a limit on deductions for state and local taxes, as well as interest on home mortgages. What do you think about that and how might that affect investors?

Craig Richards: Yeah, so let's just talk about where we are right now. So, SALT or state and local taxes, had been essentially fully deductible. So, it didn't matter if you had real estate taxes. If you had state taxes, city taxes, foreign tax, real estate tax that you might've been paying, all those items you were able to deduct if you itemize your deductions, and there was no limit on the amount that you could take. Under the Tax Cuts and Jobs Act that went into play in 2018, taxpayers were limited to $10,000 per return. So, it didn't matter if you were single or married filing joint, the amount that you could deduct, irrespective of whatever you paid, is $10,000. And we believe that would stay true under a Republican administration going forward. However, Democrats want to undo that. They don't want to have a SALT limitation of $10,000, and we think that under a Democratic regime that the SALT limitation would be repealed.

Stephen Dover: So… in addition to changes in the SALT - state and local tax limitation, is there a proposal for changing the mortgage interest deduction?

Craig Richards: There was a change under the Tax Cuts and Jobs Act, where mortgage interest was limited, in past law, up to $1,000,000 worth of indebtedness. There was a change for any mortgages that were taken out after the Tax Cuts and Jobs Act went into play of the interest on only $750,000 worth of mortgage indebtedness is now deductible. So again, I think under a Republican administration, it probably stays like that. And Vice President Biden hasn't, to my knowledge, hasn't opined on changing the mortgage interest deduction. So, we haven't heard about that. The only thing that I would add is that we believe that part of his proposal includes capping itemized deductions for certain folks at 28% of their income. But as far as the mortgage interest deduction goes, we're not sure that there would be any changes there specifically.

Stephen Dover: One of the effects of the pandemic has been people working at home and many people working in different states from where they worked before. Are there any tax implications of this or working from home?

Craig Richards: Yeah, I think a lot of people are reevaluating where home is. So, businesses are finding out that people are able to work from home very easily. And even after this pandemic is over with, we think that businesses are going to change their models. And that means that folks that were made to come into the office every day will now be able to work out of home, maybe part of the time, maybe all the time. And if they're able to work from home, where home is, it could change for a lot of people and I think that one of the criteria that's on folks’ minds is I want to live in a lower tax rate jurisdiction. So if I live currently in New York City, or if I live in California and I'm paying a very high rate of tax, what about going to a state like Florida, or going to a state like Texas, or someplace that doesn't have an income tax? I think people are thinking about that and they're running the numbers right now. I know that I get that question most every day.

Stephen Dover: Craig any tax planning or thoughts people should have around their retirement plans?

Craig Richards: I think that everybody should make sure that they are funding their retirement plans. I think during these times, the pandemic, I think with cash flows that might not be at the forefront of their minds, but I think that they should be looking to find ways to, if they can, to make sure that they're fully funding their retirement plans. And the other thing is for folks that do have retirement plans who do have IRAs, under the current tax regime, look to see if it makes sense to take that IRA and convert it over to a Roth IRA. If there's a potential to have higher tax rates in the future, and they might pay more tax in converting that, they should absolutely be running the numbers to think about converting in the current year.

Stephen Dover: Craig, any special tax planning ideas that people nearing retirement should be considering?

Craig Richards: I think that anyone who's near retirement, if they haven't been already, they should be working with their advisors. They should be working with their financial planner, their wealth manager, their portfolio manager, making sure they have a plan in place, run a financial analysis, make sure that you're okay as far as cashflow goes, make sure you have the right balance in your asset allocation. I think being proactive, that's the best thing that folks can do at this point in time.

Stephen Dover: Craig, the election's a few weeks off, we don't know the results of the election, and even if we did, we don't know what real changes are going to happen. Should investors just wait and see what's going to happen, or should they start planning now?

Craig Richards: I think investors need to start thinking about it now. I mean, they have until the end of the year, if we were to assume that changes will happen retroactive to January 1st, 2021, but you want to think about things now. You want to think about anything that you can do currently that's going to save you either income taxes or estate taxes in the long run. So, the sooner you start planning for that the better off you're going to be.

Stephen Dover: Craig, thank you for speaking to us today. I think what I got from this is that we shouldn't actually wait till the election to start thinking about tax planning. That it's time now to talk to our tax advisor, both in terms of our income taxes as well as in terms of our state taxes. Thank you very much Craig.

Craig Richards: Thanks Stephen. Thanks for having me. I really appreciate it.

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