Doug Houser: From Rea & Associates Studio, this is unsuitable, a management financial services podcast for entrepreneurs, tenured business leaders and others who are ready to look beyond the suit and tie culture for meaningful measurable results. I'm Doug Houser. On this weekly podcast thought leaders and business professionals break down complicated and mundane topics and give you the tips and insight you actually need to grow your business. If you haven't already, hit the subscribe button so you don't miss future episodes, and if you want access to even more information, show notes and exclusive content, please visit our website at www.reacpa.com/podcast and sign up for updates. 2021 has been another crazy year for everybody, and businesses everywhere continue to feel the pinch of a recovering economy. Even though federal and state government entities continue to do what they can to ease the burden on our business sector, there continues to be questions and concerns when it comes to taxes and regulatory requirements and changes going forward, most certainly. On this week's episode of unsuitable, tax guru and Rea principal, Chris Axene, is here to give us some insight into the current tax climate, as well as provide us a glimpse into his crystal ball, which I always find fascinating. Welcome back to unsuitable, Chris.
Chris Axene: Thanks Doug. Glad to be here. Thanks for having me and plenty of mundaneness coming in this week's episode here. Doug: Yes. Well, I don't know about that. I think it's a topic of great interest obviously to our audience of business owners, and when I'm with clients and prospects or other third-party advisors, the first question out of their mouths right now is, hey, what's coming down the pike? Where are we headed with tax law changes? And obviously none of us know that. We'll get into that outlook probably towards the end of this episode. But I certainly think it's at the forefront of everybody's mind who's a business owner.
Chris: I've become popular again.
Doug: Yeah, exactly. Yeah, and different planning opportunities may arise that we haven't probably dealt with in a while. We'll see. But talk a little bit about what already has happened this year. Maybe start with the ACA, Supreme Court case update-
Chris: Yeah.
Doug: And some of the things that we know are in the bank, so to speak, and have occurred.
Chris: Sure. Yeah. A couple of quick hitters to update our listeners here. In prior podcasts, I informed the listeners about an opportunity potentially for taxpayers with regard to the Affordable Care Act, and that the Supreme Court had agreed to hear a case regarding the constitutionality of the net investment income tax as a funding mechanism for the Affordable Care Act. The court took up that case in it's termed that started last October. Last year around this time, we were, as the court had agreed to hear it, we were scrambling to file protective refund claims for clients for 2016 and 2017 as those years were quickly going to run out of statute. That was to preserve the right if the Supreme court ruled in our client's favor in terms of the net investment income tax was not a valid tax, that then we could file actual amended returns to refunds back. They weren't insignificant dollars by any stretch for many of our-
Doug: Right.
Chris: High net worth taxpayers and business owners that really encompasses, there was two pieces to it. There was a 0.9% on excess compensation above 250,000 Medicare tax and then there was the 3.8% on investment income, so interest dividends, cap gains. To fast forward, I think it was in, well, it might've been in May the Supreme Court issued their ruling, and basically came down and said the plaintiff didn't have standing. So they really didn't discuss the merits of the case as to whether it was constitutional or not, the funding mechanism. But basically said, well, the plaintiff doesn't have standing to bring it so we're basically throwing out it out for that. So for now, that forecloses that opportunity. We'll see if it comes back again at some point in the future, but I know within our firm there were probably 40 or 50 protective refund claims filed on behalf of clients for '16 and '17, and the IRS was issuing acknowledgement of that in an indirect way. Now I would expect that, who knows when, but at some point there'll be a follow up from them saying, hey, we're going to basically put this in the trash because it's no longer available.
Doug: Yeah. It seems like they punted that one, so not sure if we'll ever see that revisited.
Chris: Yup.
Doug: Who knows. But good news though on the front of the employee retention credit. That was expanded and I know made more widely accessible, and we were in the process and have already done so for a number of clients to take advantage of that. Talk a little bit about what happened there.
Chris: Well, we have lots of clients that are going to be able to take advantage of this and get free money back with regard to the payroll taxes on their workforces that were impacted by COVID. A couple of different pieces of legislation favorably impacted what had been passed in the CARES Act last year. The first one was the consolidated appropriations legislation that got signed at the end of 2020, which basically broadened extended at number one to Q1 and Q2 of 2021, and then also at a high level it expanded the benefit from 50% to 70% of the first 10,000 in wages per employee, so basically a $7,000 credit refundable, money back. There was a subsequent piece of legislation, the American Rescue Plan Act, that was passed here in the spring that extended that through the Q3 and Q4, so through the end of 2021. As a part of those the criteria for qualifying loosened up a bit.
Doug: Yup.
Chris: That obviously brings in more businesses that can now take advantage of it.
Doug: Yeah, it's interesting because I had a number of clients even in construction, which really to a large extent still ran very strongly last year. In fact, a number of experienced record years. But if you're comparing it back to say a quarter in 2019, and if you just perhaps had one quarter that's all of a sudden 20% down versus what you saw in 2019 you would qualify. Again, as you said, it can be significant dollars. Think about it, if you have 50 employees at seven grand a pop that if they're earning at least 10,000 in that quarter, that's 350 grand. So it's substantial money for sure.
Chris: Yeah. Yeah. I in particular have a client that had a casualty event this spring. It was covered by insurance, but nevertheless has an impact to his business, and was pleased to be able to inform him petty qualified and was going to be getting a significant money back from the IRS here related to 2020.
Doug: Yeah.
Chris: Now I guess the rub of it all now is can we file those many returns, payroll returns, and we just need the IRS to cooperate and issue refunds. They're tight.
Doug: Right. Yeah, exactly. And certainly there is some complexity. We spend a lot of time dealing with, okay, the interplay between those wages that can be used for employee retention credit versus PPP, because you can't double dip-
Chris: Yup.
Doug: And some other factors such as that. Speaking to the IRS, I've heard a lot of rumblings, and we'll get into this here with new proposed tax changes, that boy, they're really going to beef up enforcement and these types of things that's supposedly part of the pay for with the infrastructure bill that seems to have been negotiated. Can you provide us any insight on that?
Chris: I can confirm that kind of goes back to the so-called tax gap, so the estimate of what the taxes that are believed to be owed by, collectively, us as taxpayers versus what is actually paid. That gap is under reported income over reported expenses. A significant part of it is with regard to offshore accounts. The IRS has been hit in a couple of different ways over the last 5, 10 years with regard to people retiring. They're seeing decreases in their workforce because of that, cutting of funding through some abuses by individuals within certain sections of the IRS that made the news. They were in a way probably operating with one arm behind their back, and audits, it's not a secret audits are down generally across the board in terms of all income ranges and entity types. They still go on and are happening, but not as frequent as I guess some would like. The hope with that is if you throw some money at them to increase their budget, allow them to hire people and focus on particular initiatives like the offshore under reporting and auditing large companies as well to try to close that tax gap and therefore help pay for some of the other provisions that they want to pass.
Doug: And of course as you noted, they'll target really the low hanging fruit or where the biggest bang for the buck likely is. Doesn't necessarily mean our average taxpayer should be frightened, but certainly it raises awareness. It's something we're going to be following I would imagine.
Chris: Yeah. I think as a general proposition, the areas of interest to the IRS really haven't changed, it's just they didn't have the people to really focus on it. I think we know where that low hanging fruit is to advise taxpayers that may find themselves there to here's what's coming and here's how best to prepare for that. Of course, if they've hired a competent advisor it's not that they've done something wrong, it's more of ... And sometimes things change, the IRS changes their opinion on deductibility and inclusion income, et cetera. Yeah, we'll see how it goes. But I expect that to stay within any compromise that comes about here if and when we get some legislation this year.
Doug: Right. All right, speaking of the crystal ball or maybe I should call it Magic Eight Ball when it comes to predicting the legislative tax, what gets done in terms of progress, what can we look for? What can we see? To me, I see a lot of people overreacting or just freaking out about, oh my gosh, my capital gains or my state tax exemption. Where do you really see things coming down?
Chris: Well, let me start, I guess, with this to frame the context of where we are. Based on the legislative calendar, roughly speaking plus or minus, there's about 70 days left in this year for them to get something done, and that's spread over multiple months.
Doug: Right.
Chris: It's not like we're talking two and a half months, because they're not working every day, no surprise there. It's somewhat shocking how little I suppose they do work in terms of the number of days they're in session. So absent some extending their days in session like through the August recess, et cetera, there's not a lot of time because a lot of this, particularly if it's going to be ... Just think about what happened last go round with the Tax Reform Act that was passed at the end of '17. You have committees that want to hold hearings and debate the issues, and rightly so, and come to compromise, et cetera, and it's hard to do that when there's only so many days left. You have that as a starting point. You have where still Congress's attention is currently focused on trying to pass infrastructure bill, one or more. Right now perhaps there's compromise and ability to get something done with so-called hard infrastructure, the truly shovel-ready type of construction projects. As of yet nothing's been voted on. We don't have a bill to vote on. There's other things that are in front of that. Clearly it's a priority of the Biden administration, but we've got infrastructure that they want to get done, both hard and then the soft side of that infrastructure is the people side and the green energy side that Democrats really want, and if that gets passed, likely would be done purely on a partisan basis to make that happen. You have the end of the government's year is at the end of September, and the current budget will run out as of then so the continuing resolution, they've got to do another one for the next fiscal year.
Doug: Debt ceiling, right? That'll hit.
Chris: Yeah. They've got things on their plate that, at this point, have a higher priority in terms of they're already down the road, or we can't punt on the CR. We got to get it done. Again, it compresses the timeframe in which to get something done. With that as context, the green book was issued not too long ago, which is the summary in more detail of the Biden administration's ideas and where they want to go with tax law changes. I hate to call it reform, but the winners and the losers.
Doug: Yeah.
Chris: Maybe we can couch it in those terms. The big part of that always comes back to prospective versus retroactive.
Doug: Right.
Chris: If it's prospective, we have some time to plan. We can see Congress is starting to get their act in gear and having committee meetings and debating the issues. Taxpayers have some time to plan here in what would be the rest of 2021 to try to do efficient tax planning.
Doug: Sure.
Chris: Part of what was in the green book is there was a provision related to capital gains, which the Biden administration has said for the rich, those that make more than a million dollars, they want those capital gains to be taxed as ordinary tax rates, which would go up to 39.6 from where they are, the ordinary rates from 37% now. But effectively, the highest capital gain rate is, without the impact of the surtax, is 20% and going to 39.6 So it's basically doubling it.
Doug: Yeah.
Chris: The green book indicated that the effective date for that would be as of the date of the announcement, not potentially a prospective like January 1st, 2022. The date of the announcement was April 28th, 2021, so retroactive based on the time when legislation would be signed, and that of course would be devastating for tax planning because it's too late.
Doug: Right.
Chris: I think what'll happen is hopefully there'll be some arm wrestling and haranguing and negotiation and that gets moved-
Doug: Yeah.
Chris: That yardstick so to speak. The history of retroactivity tends to be when it's taxpayer favorable you can have that and we've seen that multiple times with tax credits that have expired, et cetera.
Doug: Yeah.
Chris: When it's punitive, not as many examples of being retroactively enacted. So hopefully that would, again, prove true here, and in doing so would allow us some time to help our clients plan because that's what they want to know.
Doug: Right.
Chris: If tax rates are going up and I'm thinking of selling something anyway in my security and my portfolio, then I want to do it sooner than than January.
Doug: Yeah. We're certainly that with M&A activity we've seen a number of folks. I know transactions you and I have both been involved in were, and I always say it should be a factor. It should not be the factor, and we don't want people to overreact in that sense, right?
Chris: That's right. Yes. The taxes should never be the primary reason why you're doing something. You should understand the ramifications, and if it makes sense within the larger business deal to try to negotiate for a better deal tax wise, whether that's with regard to timing or otherwise, then absolutely. But yeah, you don't want to kill a really good deal for 99% of other reasons just for a tax thing.
Doug: Which we don't even know will happen yet.
Chris: Correct, yeah.
Doug: My feeling, again, this is Doug's opinion only, not the firm's opinion, not your opinion. But I just can't see enough traction to make that massive of a change with cap gains, but who knows. I've been wrong before, so we'll see.
Chris: What's interesting is, and again, we're in wait and see mode and watch. It's not an understatement to say if it's not every day it's every other day, somebody's calling asking, well, what's going to happen? What does it mean? When's it coming and how much? All we can do is stay tuned. But I think the hope is that there are a group of moderate Democrats, and really right now in the Senate, any Democrat if they so chose, is wielding some weapons and leverage because they need every single one of them.
Doug: Yeah.
Chris: The poster boy for that is Joe Manchin. He's seems to have been willing to take all the arrows so far. But there's others that are out there too that could prove to be beneficial to taxpayers in helping to mold something that's prospective, not retroactive.
Doug: Yeah. The other big one, certainly last that we want to touch on, is the proposed state tax exemption change. Let's talk about that, because that could potentially have a big impact, particularly for all of our business owners out there, right?
Chris: Yeah. There's lots of, again, lots of moving parts to this. The current lay of the landscape is right now, the lifetime exemption amount and maximum state exclusion is basically 13 million per taxpayer and if you're married that there's portability there so it's effectively 26 million for a married couple. That expires at the end of, I'm sorry, it's $23.5 million. That expires at the end of 2026. That's where the 26 is in my head if Congress does nothing. So that'll expire and it would go back to what it was previously, which is basically five and a half million each with portability. From what I've read, I think that's at least initially where I think the Biden administration is okay with it going back to, that five and a half million dollars. But there's a bunch of other things that are different and not good in terms of the potential elimination in the step up and basis rules for inherited property. Basically you'd have a deemed sale at death-
Doug: Right.
Chris: And the estate would pay that tax. There's some provisions that would limit the amount of lifetime giving while the individual is alive. Right now, it's those two, the gift exclusion and the death, exclusion, if you will. The state exclusion are one and the same and tied together. You can either give away eleven and a half million during your lifetime, or you can not give away anything and then give eleven and a half million when you die. It's the same thing. They would disconnect those under Biden's proposal, and significantly reduce how much you could give away tax free during life.
Doug: Yeah. Those are obviously some significant things that we'll be watching among other things as we proceed. I'm sure we'll have you back on to discuss as we learn more and maybe we get at least some proposals towards the end of this year, we'll see. But it sounds like it's interesting that you bring up the legislative calendar on really how short of a timeframe there is to get something done this year.
Chris: Yeah. We've seen them motivated before. Again, I guess we just stay to see, and I will be keeping my ear to the ground-
Doug: Yes.
Chris: And my hotline to Washington open, and I will promise to report back as soon as I know something good-
Doug: Excellent.
Chris: And concrete.
Doug: Well on another note, how's the golf game right now? I think last time we were out I lost three bucks or so too you. I got to get that back here soon.
Chris: Well, it's going good. I might've won another five dollars in a different game a week later. I didn't quite play as well as I would've liked, but it was good enough.
Doug: That's right.
Chris: But yeah, this is the time of the year where I'd like to play once a week. That's not going to happen this week, but hopefully next week.
Doug: Yeah, sounds good. Well, thanks again, Chris. We always love having you on and we will I'm sure have you on again soon, because this is certainly important for all of us.
Chris: Absolutely. Thanks for having me.
Doug: Appreciate you staying on top of it. Well thanks again, and if you want more business tips and insight or to hear previous episodes of unsuitable, visit our podcast page at www.reacpa.com/podcast, and while you're there, sign up for exclusive content and show notes. Thanks for listening to this week show. Be sure to subscribe to unsuitable on Apple Podcasts, Google Podcasts, wherever you're listening to us right now, including YouTube. I'm Doug Houser, join us next week for another unsuitable interview from an industry professional.
