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President Elect Biden’s Tax Plan
There is still a lot of uncertainty surrounding the recent Presidential Election, but it appears Joe Biden and his administrative will take over in January. President Elect Biden has released his tax plan which includes increased tax benefits to some and much higher tax bills for others. Let’s dive into the five largest proposed changes and then discuss the likelihood of its affect on your family’s annual tax burden. But first, what will it take to see any tax changes to begin with?
The Legislation Process
For a traditional tax bill to become law it needs a majority vote in the House, at least 60 votes in the Senate, and a signature by the acting President. Joe Biden and Kamala Harris are the projected winners of the 2020 Presidential Election and the Democratic party is expected to retain control of the House of Representatives. The current Senate tally has Republicans with 50 seats and Democrats with 48. Two seats remain undetermined with a pending runoff election in Georgia on January 5th. Regardless of the runoff results, one might think any tax policy changes are impossible with neither party holding 60 votes in the senate and no bipartisanship on tax policy.
However, an alternative procedure known as a budget reconciliation can make tax policy changes up to a limited dollar impact on the federal budget with a simple majority vote in the Senate. In fact, this reconciliation process is how Trump passed the Tax Cuts and Jobs Act at the end of 2017 without one vote from the Democratic party. So, to see any of Biden’s tax proposals, Democrats need to win both Georgia runoffs resulting in a 50/50 Senate leaving Kamala Harris to cast the tie breaking vote as is the role of the Vice President. If Republicans win one of the Georgia runoffs, Biden will need a vote from across the aisle, unlikely.
President Elect Biden has guaranteed he will not increase anyone’s tax burden who makes less than $400,000. The plan is currently lacking details on whether this $400,000 threshold is adjusted gross income or taxable income or some other metric, but the idea is the proposed changes are very targeted. Let’s take a look at the more impactful considerations.
Social Security Tax Increase
The social security tax is currently a 6.2% flat rate on employees and a 6.2% flat rate on employers for every dollar of wages or self-employment income up to $137,700 (for 2020). Every dollar of wages or self-employment income above $137,700 is not subject to social security tax effectively capping the tax per employee salary at $8,537 on the employee and $8,537 on the employer. Biden’s proposal would create a donut effect reinstating the 6.2% tax on wages and self-employment income over $400,000. So, the combined employer/employee rate would be $12.4% up to $137,700, then a 0% rate between $137,700 and $400,000 and then brining back the 12.4% rate on every dollar above $400,000.
Capital Gains Rate Increase
The current top ordinary income tax rate is 37%. Capital gain income which includes qualified dividends and the appreciation on the sale of capital assets held longer than one year has a special lower rate. The highest capital gain rate is currently 20% when married filers have income over $441,451 in 2020. Biden would increase this rate from 20% to 39.6% when income is over $1,000,000. The proposed plan currently lacks details on how this $1,000,000 will be determined and implemented but nonetheless for very high-income earners the tax on dividends and long-terms gains would nearly double under this proposal.
Corporate Tax Rate Increase
President Trump’s Tax Cuts and Jobs Act reduced the income tax rate on corporations from 35% to 21%. The Biden administration suggests increasing this rate from 21% to 28% for all corporations.
Estate Tax Changes
The estate tax structure under current law is set up to tax the transfer of wealth from one generation to another. The estate tax is imposed on a snapshot of an individual’s net worth as of their date of death. Current law provides an exemption to each individual to transfer $11,580,000 (for 2020) of wealth to another generation estate tax free. Any value transferred above this threshold is subject to a 40% tax rate. While the estate tax can be a hefty burden for affluent families, there is a beneficial provision that allows for an increase in the cost basis of all the assets of a decedent upon death. This is known as a step up in basis. If you were to die owning Apple stock that you purchased for $10,000 and it is now worth $50,000, your beneficiary would inherit the Apple shares with a cost basis of $50,000. This step up in basis results in the $40,000 of appreciation never being subject to income tax.
The proposals Biden has released would change all three aspects of the estate tax regime. The exemption would be reduced from $11,580,000 to $3,500,000 resulting in more individuals being subject to the estate tax. The estate tax rate would move from 40% to 45%. Lastly, the free step up in basis would go away with any appreciation in assets being taxed at death.
Increased Tax Benefits
President elect Biden’s proposals can be seen as a barbell. As we just saw, there would be heavy tax increases for those who make over $400,000 annually. Meanwhile, the proposal greatly expands numerous tax benefits to many lower income households. A few such expanded benefits include increasing the Child Tax Credit from $2,000 to $3,600 per child under the age 6 and $3,000 per child between the ages of 6 and 17. The Child and Dependent Care credit maximum would move from $3,000 to $8,000. A new first-time homebuyer credit would be created providing up to $15,000 at the time the home is purchased. Retirement plan contributions would result in a refundable credit at an estimated rate of 26% on the amount of the contribution instead of a deduction at your marginal income tax rate benefiting lower income households.
The Tax Policy Center released an analysis of President Elect Biden’s tax proposals which put numbers to the changes above. The projected net effect is increased federal tax revenue of $2,092,300,000 between 2021 and 2030 the majority of which would come from the corporate tax changes. The barbell can be clearly seen in the distribution of after-tax income change between current tax law and Biden’s proposals.
Keep in mind, these are just proposals and there are numerous dominoes that must fall into place before any of these proposals become law. While tax planning is very important be sure not to act radically or emotionally to these proposals and take a systematic approach with your advisor on what actions to take before the end of 2020 that result in the lowest lifetime tax burden for you and your family.