Wither The Senate?
I was reviewing a reorganization plan Saturday morning – coffee and chocolate chip cookies within easy reach[i] – when an email crossed my screen with the subject line that each of NBC, CNN, ABC and the Associated Press[ii] had just “called” the presidential election for Mr. Biden.[iii]
Fine, I thought to myself, but until we know about the Senate, Mr. Biden might as well have lost the election insofar as his ambitious tax agenda is concerned.[iv]
Before the 2020 election, the Republicans held a 53-to-47 majority in the Senate. On the day following the election, many self-described “pundits” informed us that, in light of Senator Collins’s re-election in Maine, the Senate would likely remain under Republican control.[v]
As of today, however, each Party has 48 seats in that chamber[vi] and, in case you haven’t heard, the Senate races[vii] in North Carolina and in Alaska have yet to be decided – they’re still counting votes,[viii] though by some accounts the Republican Party expects to win those contests. If that turns out to be the case, the Republicans will hold 50 seats in the Senate as compared to 48 seats for the Democrats. Which brings us to Georgia.[ix]
Georgia on My Mind[x]
Both of Georgia’s Senate seats were up this year – and both those seats will be decided by runoff elections to be held on January 5, 2021.[xi] In order for the Democrats to control the Senate, they will have to win both Georgia races,[xii] which will bring them even with the Republicans, at 50 seats apiece. In that case, Ms. Harris, as Vice President, would have the tiebreaking vote.[xiii]
Thus, we will not know until early next year whether Mr. Biden will have the luxury of a supportive Congress, or whether his anticipated efforts to change the Code will be stymied for at least two years by a Republican-led Senate.[xiv]
If Georgia gives the Democrats two more seats in the Senate, we should expect a number of changes to the Code, none of which bodes well for the tax burdens imposed upon the owners of a closely held business.[xv]
As if to ensure this outcome, among others, Ms. Ocasio-Cortez told the New York Times during a Saturday interview that, not only must Mr. Biden pay attention to the Party’s “progressive” wing, he must also appoint progressives to top positions in the new administration.[xvi] She added that the Democrats will lose seats in 2022 if the president fails to work with the progressive members of the Party.
Midterm – Already?
Speaking of 2022, many scholars and political analysts have observed that midterm elections “are not friendly to the president’s political party. Modern midterm elections have resulted in an average loss of 30 seats in the House of Representatives and Senate by the political party whose president occupies the White House. . . . And with few exceptions, they’re pretty ugly.”[xvii]
Before we start thinking too much about the 2022 midterm elections, however, we first have to see whether Georgia will deliver for the Democrats.[xviii] It may not – Mr. McConnell seems to believe the Republicans will take at least one of those races[xix] – in which case closely held businesses and their owners will probably not have to plan for immediate and substantial tax increases.
Politics as Usual?
That is not to say that a Republican Senate would not consider cutting a tax-related deal or two with the President[xx] and the Democrat-controlled House in exchange for a meaningful concession on some other matter – under the right circumstances, it probably would. However, the chances of the Republicans’ also agreeing that any such legislation be given retroactive effect to the beginning of 2021 are remote.
Moreover, it is doubtful that the Republicans would agree to any significant changes, and it is equally unlikely that Mr. Schumer is capable of wooing any of them into crossing the aisle to vote with the Democrats, at least with respect to major changes to the Code.
Indeed, if the Republicans retain the Senate – after gaining seats in the House, as they are projected to do – notwithstanding the record billions spent by the Democrats,[xxi] I doubt they will readily abandon their positions with respect to the corporate income tax, most business deductions,[xxii] and the estate tax, as most recently reflected in the Tax Cuts and Jobs Act.[xxiii]
“What Ifs”
What if the Republicans retain control of the Senate, albeit by the skin of their teeth?
What if, notwithstanding such control, they still agree to make a tax-related deal with the Democrats?[xxiv]
What if the Republicans – who are projected to have picked up a number of seats in the House once the remaining twenty-three vote tallies are completed[xxv] – hold out for the midterm elections, in the hope that history repeats itself and the Democrats lose still more seats in the House, perhaps even finding themselves in the minority?[xxvi]
What if the Republicans lose seats instead, including maybe their razor-thin margin in the Senate?
What is the owner of a business to do during the next fifty-two days – the tail-end of 2020 – in light of all this uncertainty?[xxvii]
“You Can Only Do So Much, but You Must Do At Least That Much”[xxviii]
By now, most business owners are familiar with Mr. Biden’s plans for amending the Code. Many of these changes are based upon his determination that any taxpayer who makes at least $400,000 in a taxable year is wealthy.[xxix]
Among the changes proposed by the Democrats during the presidential campaign were the following: an increased rate for ordinary income, the application of that same rate to capital gains for higher income taxpayers, a reduced itemized deduction for higher income taxpayers, imposition of the 12.4% social security tax on wages in excess of $400,000, elimination of the basis step-up for appreciated assets held by a decedent, and the reduction of the unified estate and gift exemption amount.[xxx]
At that time, we considered these tax proposals in a “vacuum,” in the sense that we analyzed them assuming their immediate enactment.[xxxi]
By now, we should have had greater certainty regarding the political and legislative context in which to place them. In turn, we should have been in a better position to answer questions and to assist business owners in preparing for, and responding to, the possible enactment of these proposals.
Unfortunately, the information we have today is not much better than what we had before the election, thanks primarily to the Georgia runoffs in January of 2021, which will determine whether the Democrats succeeded in winning control of both the House and Senate, thereby being in a position to dictate the legislative agenda in Congress for the next two years.
Again the question: what is the owner of a closely held business to do?
Assume the Worst
The safest course of action for business owners would be to assume that the Democrats will have control of the Senate come 2021, and to plan accordingly – provided such plans will not result in a reasonably foreseeable detriment to the business that will likely outweigh the tax benefit sought to be attained.[xxxii]
For example, a taxpayer who is under contract to sell property this year in exchange for one or more deferred payments of purchase price (for example, in the form of a note, an earn-out, or an escrow) should negotiate with the buyer some way to address the economic impact of a higher rate should one be enacted during the deferral period.[xxxiii]
Another taxpayer, who controls a C corporation with earnings and profits (or an S corporation with earnings and profits from C corporation tax years[xxxiv]), may want to consider the distribution of a qualified dividend this year, rather than at the beginning of the next.[xxxv]
Yet another would be well-advised to accelerate the sale of real property held for investment into this year, as the first leg of a deferred like kind exchange; if they fail to close the exchange in 2021, the taxpayer should still be able to elect out of installment reporting for 2020.[xxxvi]
An employer who normally pays key employees their bonuses for a year in the immediately succeeding year may want to consider paying them before the year-end.[xxxvii]
Finally, let’s not forget estate planning. If a business owner is already planning to make gifts of equity in the business to, or for the benefit of, their family members, but has not yet decided when to pull the proverbial trigger, now may be the time.
The prospect of the accelerated reduction, by at least 50%, of the Federal unified gift and estate tax basic exclusion amount, and of the generation skipping transfer tax exemption amount, should be incentive enough for the business owner, who faces a taxable estate, to act before the end of the year.[xxxviii]
Assume the Best
Alternatively, the business owner may take their chances that the Republicans will, in fact, take the Alaska and North Carolina races, as well as one or both of the January 2021 Georgia runoffs.
The Republicans will need to win at least three of these four contests to secure control of the Senate – the Democrats need two.
If the taxpayer is comfortable with what the Republican Party and the pundits are saying,[xxxix] then they can probably rest easy for two years – until the midterm elections – at which point they will have to revisit this scenario: “Do I act now, or wait for the outcome of the midterm election?”
Insofar as changes to the income tax are concerned, such a wait-and-see approach may be fine. In the event a tax increase is somehow enacted (perhaps as part of a larger deal), the business owner may have various options available to them by which they may reduce the impact upon their take-home profit.[xl]
As for their estate and gift tax planning, on the other hand? The premature loss of the increased exemption amounts[xli] will greatly impact an owner’s ability to pass assets along to their issue tax efficiently, especially if paired with renewed IRS regulatory activity which was suspended by the Trump administration.
Even then, however, some effective planning may still be implemented, especially in a low interest rate environment, for assets that are expected to appreciate; for example, zeroed out GRATs, or sales to grantor trusts in exchange for installment notes, which are largely independent of the exemption amount.
Decision Time
To quote Meat Loaf (sort of): What’s it gonna be? “Yes” or “No” to year-end planning?
If yes, I gotta know right now, before we go any further. Sure, you can sleep on it, but don’t take too long.
That said, having made a decision, the last thing I want is for you to be praying for the end of time to hurry up and arrive.
[i] What? Were you expecting a low fat yogurt and granola, drizzled with just a little bit of honey? The year-end calls for comfort food, especially this year, as if you didn’t know.
[ii] Each a purveyor of selective truths and of political correctness.
What’s more, when last I checked, the 12th Amendment to the Constitution governs the election of the president. The electors of the Electoral College will not meet in their respective states until December 14, 2020, and the electoral votes from each state are not due in the Senate until December 23, 2020.
Only thirty-three states have laws against so-called “faithless” electors.
When the Founding Fathers crafted the Constitution, they recognized that human beings are, and always will be, imperfect and gullible creatures. Thus, they constructed a number of safeguards into our framework of government, including the Electoral College.
[iii] https://thehill.com/homenews/campaign/524222-biden-defeats-trump-to-win-presidency .
[iv] https://www.taxlawforchb.com/2020/08/bidens-tax-proposals-for-capital-gain-like-kind-exchanges-basis-step-up-the-estate-tax-tough-times-ahead/ .
[v] The same ding-a-lings predicted a “blue wave.” Polling isn’t good for anybody. It fails to educate and, at worst, it misleads, perhaps leading some to direct their monetary support to the expected “winner.”
[vi] A net gain, so far, of one seat for the Democrats.
[vii] Thirty-three so-called “class two” seats were up this year.
[viii] North Carolina’s population is approximately 10.5 million, while just over 734,000 call Alaska home. (I suspect that a number of moose and/or brown bears may have either absconded with ballot boxes and/or shredded them to pieces.)
By the way, the NYC borough of Queens has a population in excess of 2.24 million; Brooklyn tips the scales at almost 2.65 million; Manhattan comes in at 1.6 million and change; the Bronx has over 1.4 million residents. (I know, I omitted Staten Island. I’m waiting for it to secede.) https://worldpopulationreview.com/states/alaska-population; https://worldpopulationreview.com/us-counties/ny/bronx-county-population .
For shits and giggles, as Austin Powers would say: each of Delaware, North Dakota, South Dakota, Vermont and Wyoming has a population of less than one million. One third of the country lives in California, Texas, Florida and New York.
[ix] The “Peach State.” Also known as the “Goober State,” goober being derived from the Bantu word for peanut.
[x] Willie Nelson’s version.
[xi] In accordance with Section 2 of the 20th Amendment to the Constitution, the rest of Congress will actually begin its work on January 3, 2021.
[xii] Query how much money is going to be poured into these two races over the next two months? The total cost of the 2020 election cycle has been estimated at approximately $11 billion. Large individual contributions represented the largest source of funding (almost 40%); 54% of the total cost was incurred by the Democrats. https://www.opensecrets.org/news/2020/10/2020-election-to-near-11-billion-in-total-spending-smashing-records/
What a waste of funds, especially considering how many folks are struggling to get by.
The following reflects disclosures of net wealth made by members of the House and Senate in 2018: https://www.opensecrets.org/personal-finances/top-net-worth .
[xiii] Article I, Section 3 of the Constitution. “The Vice President of the United States shall be president of the Senate, but shall have no vote, unless they be equally divided.”
[xiv] The Senate will have 34 seats up for election in 2022 – 21 Republicans and 13 Democrats.
[xv] https://www.taxlawforchb.com/2020/08/responding-to-the-democratic-partys-tax-plans/
Even if they control both houses of Congress, the Democrats will have to deal with the Senate’s cloture (or anti-filibuster) rule, which requires 60 votes to end debate on a matter – including a tax matter – and putting it to a vote, at which point only a majority will be required for passage. (There is no such rule in the House.) See Article I, Section 5, clause 2 of the Constitution, which authorizes each chamber of Congress “to determine the rules of its proceedings.”
That being said, query whether the Democrats will be able to invoke the 1974 Congressional Budget Act’s “reconciliation” rule to circumvent the cloture rule, limit debate, and put a tax matter to a vote requiring only a majority? https://budget.house.gov/publications/fact-sheet/budget-reconciliation-basics . The Act allows reconciliation to be used for legislation that addresses revenues and spending, as well as the federal debt limit. Some Democrats have already indicated that they intend to make use of this rule.
[xvi] https://www.nytimes.com/2020/11/07/us/politics/aoc-biden-progressives.html
[xvii] https://www.thoughtco.com/historical-midterm-election-results-4087704 . “In the 21 midterm elections held since 1934, only twice has the president’s party gained seats in both the Senate and the House.”
[xviii] Interestingly, even without a resolution as to Georgia, Mr. Biden has claimed a “mandate” from the American people. Even then, I’d be careful about claiming that “the people” have spoken.
[xix] Notwithstanding Biden’s showing in Georgia?
[xx] Biden is a 47-year, career politician and former colleague of many sitting Senators (1973-2009).
[xxi] Not to mention a blatantly one-sided and hostile press.
Don’t get me wrong. Mr. Trump was not suited for the White House. The press, however, cannot allow itself to behave as it has these last four years. Back to my quoting from movies, as is my wont. In “Meet Joe Black,” media executive William Parrish says the following:
I’d hoped to create something, something which could be held to the highest standards. And what I realized was I wanted to give the news to the world, and I wanted to give it unvarnished. The more we all know about each other, the greater the chance we will survive. . . . Now if we give [John Bontecou] license to absorb Parrish Communications, and he has his eye on a few others after us, in order to reach the world you will have to go through John Bontecou. And not only will you have to pay him to do this, far more important, you’ll have to agree with him. Reporting the news is a privilege and a responsibility, and it is not exploitable.
[xxii] For example, I don’t sense a lot of support for IRC Sec. 199A.
[xxiii] P.L. 115-97.
[xxiv] Something beyond agreeing that business expenses paid with PPP loan proceeds should be deductible for tax purposes. https://www.taxlawforchb.com/2020/10/forget-congress-the-irs-needs-to-reverse-course-on-the-deduction-of-business-expenses-paid-with-ppp-loan-proceeds/ .
[xxv] https://www.cnn.com/2020/11/06/politics/house-races-republicans-democrats-2020-election/index.html
[xxvi] Before the 2020 election, the Democrats held 232 seats to 197 for the Republicans; one seat belonged to a Libertarian, and five were vacant. As of today, with 412 of the 435 races having been called, the Democrats hold 216 seats and the Republicans 196.
[xxvii] Like so many others, I had hoped that Mr. Trump would not bring a legal challenge to the election results, but he has. What’s more, it seems that a number of Republicans are backing him. Although this development may complicate the nation’s political scene, it should not be considered in a business owner’s calculus.
[xxviii] Garrison Keillor, from Public Radio’s “A Prairie Home Companion” and “News from Lake Wobegon.”
[xxix] Funny, this is the same figure by which Mr. Obama identified the “wealthy” – in 2012. In today’s dollars, that figure is actually $453,461.
I guarantee you that $400,000 buys you a lot less, on an after-tax basis, in downstate New York than it does in most parts of the country. That’s more than just a function of cost of living. New York State imposes an income tax on individuals at a top rate of 8.82%. New York City’s top rate for individuals is 3.876%. The City’s bedroom communities of New York’s Nassau and Westchester counties have among the highest property taxes in the country.
Professionals starting out in New York – like professionals elsewhere – have spent years in college and graduate school to learn their trade, and have incurred significant costs in completing their educations. Moreover, they work an inordinate number of hours servicing clients and patients in a very competitive environment.
When Mr. Biden talks about rewarding “workers” instead of “wealth,” where does he place this human capital?
When this human capital dies or becomes disabled, it ceases to be productive, it ceases to generate income. This capital cannot be inherited like a portfolio of securities or real estate, it cannot fund a trust for generations.
[xxx] What else might we expect from Mr. Biden? A good place to look is the 2017 Green Book prepared by the Obama administration.
[xxxi] https://www.taxlawforchb.com/2020/10/the-election-the-democrats-tax-proposals-and-year-end-tax-planning-caught-between-scylla-and-charybdis/#_ednref37
[xxxii] “Hope for the best, plan for the worst.” Who said that?
[xxxiii] Consider something similar to a gross-up in a stock sale for which an election is made under IRC Sec. 338(h)(10) or Sec. 336(e). After all, the seller is doing the buyer a favor by accepting the deferred payment.
[xxxiv] IRC Sec. 1368(e)(3).
[xxxv] To take advantage of today’s presumably lower rates.
[xxxvi] IRC Sec. 453(d); Sec. 1031(a)(3).
[xxxvii] So as to avoid the additional employment taxes resulting from Mr. Biden’s proposed elimination of the wage cap for Social Security taxes.
[xxxviii] What’s more, they may be able to leverage their remaining exemption amount, while taking advantage of the current low interest rate environment, by transferring an equity interest in their business through a sale to a grantor trust, or a bargain sale to a family member. The use of a GRAT would prevent the allocation of the taxpayer’s GST tax exemption to the trust until the end of the ETIP period, at which point the exemption amount may be much lower. https://www.taxlawforchb.com/2020/03/think-before-you-gift-but-dont-take-too-long/
[xxxix] The first being a biased observer, the second a discredited one.
[xl] For example, cutting fat. If necessary, and if feasible, they may also adjust prices and other costs.
[xli] They are scheduled to sunset after 2025.