Financially Speaking: The End is Near…2020, That Is
Normally for the Holiday issue, I love to be jovial and discuss all the positives that we have enjoyed throughout the year. But this year feels like Ron Sterling’s “The Twilight Zone.” This was one of the introductions the show used in its five seasons: “There is a fifth dimension beyond that which is known to man. It is a dimension as vast as space and timeless as infinity. It is the middle ground between light and shadow, between science and superstition, and it lies between the pit of man’s fears and the summit of his knowledge. It is an area which we call the Twilight Zone.” If this doesn’t describe 2020, I don’t know what does.
As I write this article, we are nine days away from the election. I’m not Nostradamus predicting the winner; I’m here to discuss what you should do before year-end, after you know the election results. Hopefully by the time the Holiday Issue is published, we will know who the president will be for the next four years. The hopeful American that I am prays that regardless of who wins, he will be an incredibly successful president.
The fear of a stock-market correction as we head into the election is a real one, since this election could be disputed similar to the one we had in 2000. Do you remember the hanging chads in Florida during the George W. Bush-Al Gore election? If you are investing long term based on your goals and risk tolerance, should you really care? In 2000, between election day on Nov. 7 and Dec. 15, two days after Gore conceded the election in wake of a Supreme Court ruling that ended the recount, the markets fell 8.4%. Is that a big deal? Maybe in the short term, but in reality, no. Earlier this year on Feb. 20, the markets started dropping as the coronavirus outbreak spread worsened substantially outside of China. By March 23, the market was down 33.7% due to the panic. As of Oct. 23, the S&P 500 was up 54.9% from the close of the market on March 23. Year-to-date, the S&P 500 is up 6.4%.
In reality, there are many concerns with the outcome of the election, but if you are a long-term investor, chances are you should be fine. Over the past several years, I’ve stressed investing based on how much risk you are comfortable accepting to meet your goals. If you’ve designed your portfolio that way and rebalanced it every six months or so, you should be in a comfortable position.
Based on the polls (can you really trust them?), Joe Biden is favored to win the election. If by the time you read this, Biden is the winner, and the Democrats have taken the Senate, then there might be some major changes to the tax code.
First, you should look at taking capital gains before year-end. Why? Because you know what the long-term capital gains tax rate is in 2020. Next year, if you are a high-wage earner with an income of $1 million or more, then capital gains might be taxed as ordinary income at 39.6%. Currently the top capital-gain rate is 23.8% if you earn $250,000 or more as a joint filer, or $200,000 for other taxpayers. I recommend discussing this with your CPA or financial adviser.
The Social Security tax is 6.2% for both the employer and employee. The current tax rate for Medicare is 1.45% for both the employer and employee. The two taxes are generally referred to as payroll taxes. Once you earned $137,700 this year, you stopped paying the Social Security tax but continued to pay the Medicare tax for every dollar you earn. Under the Biden plan, it is similar to now but changes at $400,000 of earned income. Joe is calling this a donut hole, meaning you stop paying into Social Security at $137,700 and once you earn $400,000, you start paying the Social Security tax again. If you are high-wage earner, your marginal tax rate could be 47.25% without consideration for your state income tax. If you are a business owner or self-employed, you pay both ends of the Social Security and the Medicare tax. So, if you are a high-income, self-employed business owner, you possibly can be paying 54.9% taxes, not including your state income tax.
I believe regardless of who our next president is that there will be adjustments made to the Social Security tax. Eventually, you might pay the Social Security tax on every dollar of earned income. If this happens, this would keep Social Security solvent for decades to come. The only problem might be Congress, which probably will figure out a way to borrow from the Social Security Trust.
Another issue is the estate tax, more commonly referred to as the death tax. The estate tax is paid by the estate itself before distributing any assets to the heirs. The current law allows an individual to leave up to $11.58 million without incurring any federal estate tax, or $23.16 million per couple. Biden plans to return the exemption to 2009 levels and raise the estate tax rate to a max of 45%. That’s not really troubling, since estate-planning attorneys will devise a way for well-to-do clients to avoid death taxes by utilizing various trust instruments.
The surprise is that Biden wants to limit the step up in cost basis at death. This certainly affects everyone reading this article. Under current law, the cost basis, or what you paid for the investment, is valued at the current market value at the owner’s death. Basically, you can inherit an asset, which has grown substantially, and have a zero capital gains tax at death. Let’s say that your parents purchased the family shore home years ago for $300,000, and at the time of their death it is worth $1 million. Currently, the house value would be stepped up to $1 million at death. This means that as an heir, if you sold it immediately after receiving it, then the tax would be zero. Under the Biden plan with the elimination of the step up in cost basis on example above, you would have to pay capital gains on $700,000. For many of you reading this, your shore properties are worth more than $1 million.
Another tax that might affect many of our readers is the tax on gains of real property if exchanged for a “like-kind” property. Many have heard this referred to as 1031 real estate exchange. Basically a 1031 exchange gets its name from section 1031 of the Internal Revenue Code, which allows one to avoid paying capital gain taxes. This happens when you sell an investment property and reinvest the proceeds from the sale within a certain time limit into a similar property or properties of like-kind of equal or greater value.
None of the above is meant to frighten or scare you, it’s just to make you aware of what might happen in 2021. The possible tax changes are just some of those that might be passed next year. Before year-end, contact your financial and tax advisers to see how you may be affected. Once you sing “Auld Lang Syne” at midnight Dec. 31, it will be too late to make any additional changes before any new law takes effect.
So, let’s put 2020 in the books and say good riddance. Hopefully by year-end, we will have a cure or vaccine for COVID-19, and we can all get back to living our lives how we were accustomed.
I want to wish each of you a Merry Christmas or Happy Hanukkah, and hope 2021 is one of great health, happiness, and prosperity!
Fred Dunbar, CLU®, ChFC®, RFC®, AIF®, is President of Planning Directions, Inc., a registered investment adviser, and Common Cents Planning, Inc. He also offers securities through Commonwealth Financial Network, member FINRA/SIPC. Advisory services offered through Planning Directions, and fixed insurance products and services offered by Common Cents Planning, are separate and unrelated to Commonwealth. Fred may be contacted at 800-647-0762, by e-mail at fdunbar@commoncentsplanning.com or by mail at 239 Baltimore Pike, Glen Mills, PA, 19342. He’s always happy to meet with you “down the shore” at 6606 Central Avenue N. Sea Isle City, NJ. 08243.
