As I write this article, Joe Biden will be our next president and the Democrats will retain control of the House of Representatives. Control of the Senate is still up for grabs, pending the result of two Georgia run-off elections in January.
01/06/21 Update: The Associated Press has called both Georgia Senate elections for the Democrat candidates. This means the house will be split 50-50 with Vice President-elect Harris casting any tie-breaking votes.
Although coronavirus and the economy dominated much of the political discussion leading up to the election, both Trump and Biden released their tax policy proposals. Biden’s tax plan proposes to at least partially reverse some of the Trump tax cuts enacted in 2017. Biden’s plan means at least some individuals and businesses, including forest landowners, will potentially pay more taxes in the coming years if his tax reform is enacted.
However, Biden’s plans will likely not be successful unless Democrats win the Georgia run-off elections or can convince a few Republican senators to vote for Biden’s tax reform. Since the second scenario is unlikely, Democrats will need majorities in both the House and the Senate in order to pass new tax laws.
01/06/21 Update: With Democrats controlling both the House, Senate, and Presidency, it appears extremely likely that any proposed tax reform will be enacted into law.
Although it is currently uncertain whether Biden will be able to enact his tax law proposals, let’s look at what Biden’s tax plans could mean for forest landowners’ taxes:
1) Increased Top Rate on Long-Term Capital Gains
Electing capital gain treatment on timber sales is one of the best ways for most forest landowners to lower their tax bill. Long-term capital gains are taxed at a maximum rate of 20%, while many forest landowners likely pay 15%. These rates are much lower than the ordinary income tax rates, which currently peak at 37%.
The capital gain election for timber sales would remain, but Biden would increase the maximum rate on long-term capital gains from 20% to 39.6%, effectively removing the benefit of a capital gain election from high-income forest landowners. However, this top rate would only apply to individuals with income over $1 million, so only the wealthiest forest landowners would be affected by this change.
2) Increased Top Rate on Ordinary Income
Ordinary income (income that does not qualify as long-term capital gains such as wages, interest income, and other business income) is currently taxed at a maximum rate of 37%. Biden would increase this maximum rate from 37% to 39.6% for single taxpayers earning more than $520,000 and married taxpayers earning more than $620,000. Like the increased rate for long-term capital gains, only high-income forest landowners need be concerned with this possible change.
3) Elimination of the 20% Qualified Business Income Deduction
Forest landowners are currently eligible for a 20% deduction on their qualified business income (QBI) if they operate their timber activity as a business. Although most forest landowners should utilize the capital gain method to lower their taxes, not all do. For those who do not elect capital gain treatment, the 20% QBI deduction greatly reduces their taxes. Most forest landowners cannot benefit from both the QBI deduction and the capital gain method.
Biden has proposed eliminating this deduction, but only for taxpayers with taxable income over $400,000. Similar to many of Biden’s other proposals, the elimination of the QBI deduction targets high-income business owners and would only affect forest landowners with taxable income greater than $400,000.
4) Increased Corporate Tax Rate
Many forest landowners do business as an LLC, partnership, S-corporation, or sole proprietorship. These landowners pay the individual long-term capital gains and ordinary income tax rates discussed previously.
Forest landowners who do business as a corporation are subject to a different set of tax rates, the corporate tax rates. Prior to Trump taking office, the corporate tax rate was 35%. The Tax Cuts and Jobs Act of 2017 lowered this rate to its current level of 21%. Biden would raise the corporate tax rate to 28%.
Biden’s proposal is a significant increase from the current corporate tax rates, but will likely affect only a select few forest landowners who own their farms through a taxable corporation.
5) Increased Estate Tax
Currently, a 40% tax is owed upon death of an individual’s “taxable estate.” However, most individuals are not subject to the estate tax because of the large exemption. Under current law, an individual only has a taxable estate if they own more than $11.58 million in assets ($23.16 million for a married couple).
Biden would decrease the exemption to $3.5 million ($7 million for a married couple) and increase the estate tax rate to 45%. An increased estate tax and decreased exemption amount will affect many more forest landowners than the current estate tax law does. Forest landowners who own significant assets close to or exceeding Biden’s proposed exemption amounts should consult with an estate planning attorney to determine possible steps to minimize future estate tax liability.
Some Good News
Although Biden has proposed many tax increases, his proposals are not all bad news. Biden has said that no one who earns under $400,000 will face a tax increase, which appears correct. Further, he plans to add and expand many individual tax credits, such the child and dependent care credit, an elderly relative caregiver credit, and a first time homebuyer credit. Many forest landowners with families will likely qualify for these credits to reduce their tax bills.
Conclusion
A Biden presidency will likely mean higher taxes for high-income forest landowners or those who use a taxable corporate entity. A forest landowner who has income of less than $400,000 per year would likely not face increased taxes under the Biden administration and may qualify for additional tax credits.
Every forest landowner who thinks he may be subject to higher taxes or may have a taxable estate upon death should consult with a knowledgeable tax professional for proactive tax planning. Regardless of income level, every forest landowner should consider making a capital gain election because it is one of the best strategies for forest landowners to save taxes that will likely not change with the Biden administration. Further, every forest landowner should also review their timber basis calculations to ensure they are maximizing their basis to minimize their taxes.
Interested in hearing Andrew speak live about saving taxes? Make sure to attend his webinar on January 12, 2021!
