As we enter the end of summer, fall—and election season—is right around the corner. For more than a few reasons, the 2020 presidential election is poised to be one of the most intense, and it’s only a matter of time before we start seeing campaign plans kick into high gear.
With that in mind, Democratic nominee Joe Biden recently proposed how he would change tax laws if elected. While these early ideas rarely materialize exactly the same in formal legislation, they do provide direction for what one could expect if Biden becomes president (and other Democrats win enough Congressional seats to take control of both the House and Senate). Given that legislative changes passed in 2021 could retroactively apply as of the beginning of the year, it’s important for you to understand how these proposed changes may impact you so that you can adapt your financial plans accordingly.
The Basics: Taxes Would Increase for High Income Earners
The Biden tax plan is broad, and while there still aren’t many details, a framework does exist. Essentially, the goal is to raise $4 trillion of new revenue to fund social and economic recovery programs, and much of this additional revenue would come from increased taxes targeting high net worth individuals. For the purposes of this tax plan proposal, “high net worth individuals” means anyone earning more than $400,000. Meanwhile, those earning less than $400,000 would not, at least initially, experience an increase in taxes.
The Biden tax proposal looks to increase:
- The tax rate for C corporations
- Payroll taxes on high earners
- The top income and capital gains tax rates for individuals
- The federal estate tax
Ordinary Income Rates Rise for Wealthy Taxpayers
Currently, the highest federal income tax rate is 37% with additional brackets at 35%, 32%, 24%, 22%, 12%, and 10%. The new tax proposal would apply a higher 39.6% tax rate on ordinary income in excess of $400,000, effectively raising part of the 32% bracket, all of the 35% bracket, and the top rate from 37% to 39.6%.
This means that all individuals earning more than $400,000 would experience an income tax increase. Conversely, taxpayers earning $400,000 or less would not be affected by the new tax rules and not see their income tax rate change.
Deductions Get Reduced
Another major change affects tax deductions. Currently, the standard deduction for those married filing jointly is $24,800 (or $27,400 if you’re both over the age of 65) and $2,400 for single filers. In the proposed tax plan, this is unaffected.
Itemized deductions, however, do not face the same fate. Currently, there are no limitations to the total amount of itemized deductions you can claim on your return. In the new proposal, however, the actual tax benefit you can receive for your deductions is capped at 28% of your income. Additionally, the PEASE Limitation returns, which reduces your itemized deductions by 3% of your adjusted gross income (AGI) and up to 80% of your itemized deduction value. Both of these limitations are targeted to impact individuals making more than $400,000.
High Earners Must Also Pay More Social Security Tax
Currently, earnings up to $137,700 are taxed at 12.4% for a total of $17,074, and this dollar amount is split evenly between employees and employers.
Under the new proposal, your first $137,700 of earnings will continue to be taxed at 12.4% and you will pay no Social Security tax on additional earnings up to $400,000. Any additional earnings over $400,000, however, would be taxed at 12.4% (6.2% coming from employees and 6.2% coming from employers).
Significant Tax Increase for Capital Gains & Qualified Dividends
Perhaps the biggest proposed change to the status quo comes from how capital gains are taxed. Short-term capital gains are taxed at current income rates, so under the new proposal, this would max out at 39.6%. The big change, however, comes to long-term capital gains rates.
Right now, long-term capital gains rates are taxed at lower rates that max out at 20%, and the rate at which you are taxed is based on your total income. The Biden proposal, however, would create another tax bracket just for long-term capital gains whereby gains for individuals who have more than $1,000,000 of income would be taxed at 39.6%. This means that if your income is high enough, you no longer get the benefit of those lower capital gains rates.
Increased Estate Tax Exposure
Under current tax law, each person has a total estate tax exemption that’s capped at $11,580,000. That cap is already set to reduce to $5,600,000 in the year 2025, and the Biden tax proposal will look to bring the estate tax exemption down to at least that reduced amount in as early as 2021. Although, there are other proposals that suggest the exemption could be reduced to an amount even lower than that.
Additionally, the new proposal would eliminate the step-up in cost basis. This could be significant, because while there aren’t currently details regarding how this will be accomplished, it would at least increase the tax liability for heirs inheriting taxable items from deceased family members. This is because the step-up in cost basis currently looks to reduce that tax liability.
If you inherit your grandmother’s house after she passes away, and she bought the house for $60,000 (the cost basis), but it’s now worth $350,000, then you would have quite the capital gain on that inheritance. The step-up in cost basis revalues your inheritance to lower your capital gain and reduce your tax liability. Eliminating it would create a higher tax bill for heirs and beneficiaries, but how this will be done, and any exceptions that may apply, is not yet clear.
Business Taxes Also Increase
Businesses and corporations will also see tax increases in the new plan, as the current tax rate of 21% for C Corporations would get bumped up to 28%. Additionally, a new 15% minimum tax rate would also be put in place for large corporations currently paying no federal taxes.
However, there is a bright spot for S Corporations, LLCs, and Partnerships in the new tax plan in the form of the 20% QBI Deduction phaseout getting increased to $400,000.
This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.
CFP®, CPA, Series 7 Securities Registration,1Series 66 Advisory Registration,† Insurance License Brian diligently advises clients on income, gift, trust and estate tax issues while leveraging the expertise of the Roundtable to deliver comprehensive, customized strategies. For more than 10 years he has helped numerous clients develop and implement sophisticated financial, tax and estate strategies that are in alignment with their goals and values. Brian is a...Read More