With the presidential election just three weeks away, many of us are on pins and needles, wondering what the next four years might look like! Analysts are already outlining how the election of Donald Trump or Joe Biden will affect future tax policy, health-care reform, COVID response and vaccine dissemination, the pace of our economic recovery and the stock market. No matter who is elected, the ability to enact sweeping change quickly will depend greatly upon control of the Senate. There are 23 seats held by Republicans up for election this November, and Democrats only need to flip 3 or 4 seats to take control of the Senate.[i] If there were to be a Blue Wave, or a Democratic sweep giving the party control of both the House of Representatives and Senate, bold change could come swiftly.
For one, Trump and Biden have very different tax policies. Polls currently show Biden leading in swing states critical for his election. Some analysts feel the stock market is already settling into a Biden presidency and therefore if Biden were to win, this change would have a less dramatic impact on the market which may already be in adjustment. Specifically, Biden’s tax proposal would raise Federal income tax from the current 37% to 39.6% on high earners with income above $400,000 per year. Social Security payroll tax would remain at 6.2% for the first $137,700 of earned income. However, an additional Social Security payroll tax would be levied on earned income above $400,000. In summary, for most Americans earning less than $400,000 per year, Biden’s proposed income tax changes would not affect them.[ii]
Another Biden tax policy change relates to the tax on capital gains realized when equity holdings in non-retirement accounts are sold. Under the current law, investments held for over a year qualify for a preferential Long Term Capital Gain (LTCG) tax rate, ranging from 0% to 20% based on your income. Biden plans to eliminate the preferential LTCG and instead tax gains on investments at your ordinary income tax rate, no matter how long the investment was held. For example, for a taxpayer making over $1 million of income in a year, their tax on capital gains would increase from 20% to 39.6%.
A third notable tax reform proposed by Biden relates to the Lifetime Gift Tax Exclusion or the estate tax exemption. Under President Trump, in 2020 an American may pass up to $11.58 million per person or just over $23 million per couple to their heirs, Federal tax free. Biden proposes to reduce the estate tax exemption to $5.49 million per person or just under $11 million per couple. The tax exemption limit would be increased annually for inflation annually thereafter.
Finally, the Biden tax proposal aims to eliminate the step-up in basis rule which allows the tax on appreciated assets to be forgiven or eliminated upon the original owner’s death. Currently, the step-up in basis rule allows parents to pass highly appreciated assets, such as their house or stock investments, to their kids tax-free upon the parents’ passing.[iii] The elimination of this rule would reduce the amount passing to the child since the parents’ original basis will be used to calculate the taxable gain.
From a tax planning perspective, high income earners anticipating bonuses or non-qualified stock options next year may attempt to accelerate the recognition of that income to 2020 if they feel they will be adversely affected by the new laws. Additionally, investors who may be exposed to large taxable transactions such as gain on the sale of a second home or large stock trades might consider closing transactions now while they qualify for preferential Long-Term Capital Gains tax rates. Anyone affected by the Lifetime Gift Tax exclusion may want to consider estate planning strategies to get assets out of their estate before tax rules are changed. However, it is projected that many Americans will not be affected by the proposed tax reform, as it stands now. Further, if the Senate remains in Republican control, the actual tax changes enacted may be more moderate, as the tax changes will need Republican approval to pass.
Whoever wins this fall, nearly a century of historical market data has proven that stocks have trended upwards during both Republican and Democratic administrations.[iv] Presidents do have an impact on fiscal policy such as government spending and taxes. However, hundreds of other factors also play into the market that are outside of the U.S.’ control, such as the COVID pandemic we are currently in the middle of, actions of foreign leaders, technological advances, and so on. Further, disciplined investors with diversified portfolios are invested in companies, both domestically and internationally, large and small. Therefore the risks and volatility associated with a portfolio overweighted in one market sector are reduced, making it easier to protect the portfolio during short-term declines and get back on track quickly to capture market growth. Regardless of who is in the White House, companies will continue to focus on serving customers and growing their businesses. Therefore, as long as you keep a long-term perspective and ensure your investment strategy aligns with your goals, a prudent investment should weather the anticipated volatility through the remainder of 2020.