It is official the Democratic party controls both houses of Congress as well as the White House. This article aims to address the tax changes that they might propose as well as provide insight as to when they might go into effect. Assuming that some version of the Biden Plan is passed into law, one needs to consider its effective date. Typically, tax legislation is prospective, and might not be effective until January 1, 2022, or later (depending upon how long the enactment process takes). Sometimes, however, tax legislation is retroactive, in which case it would either be effective as of its date of introduction (which would in all events be sometime after the inauguration) or possibly even effective as of January 1, 2021.
Proposed Income and Payroll Tax Changes
- Increase the top rate for individuals from 37% to 39.6% for incomes over $400,000. At this point, we do not know if this is for single filers, joint filers, or both.
- Removal of the preferential rates for qualified dividends and long-term capital gains for taxpayers over $1 million in income. The current proposal is to tax long-term capital gains and qualified dividends at ordinary income rates.
- Putting a cap of 28% on itemized deductions and restoring the Pease limitations. Itemized deductions include charitable contributions, mortgage interest expense, and maybe state and local taxes currently capped at $10,000.
- Expand the Social Security (FICA) tax to earnings over $400,000. This change would impose a 12.4% tax on Social Security wages and self-employment income on amounts exceeding $400,000 and create a “donut hole” with no Social Security tax payable on wages and self-employment income between $142,800 (for 2021) and $400,000.
- Repeal of the Tax Cuts and Jobs Act of 2017. Biden has been in support of this repeal, but he has not come out and said specifically what he is in support of repealing at this point. A repeal of the act could result in higher individual income tax rates at multiple levels of income, a reduction of the AMT thresholds, and elimination of the 20% deduction for qualified business income, real estate investment trust dividends, and income from publicly traded partnerships. It could, however, also result in the elimination of the $10,000 cap on the itemized deduction for state and local taxes.
- The possible removal of 1031 exchanges for real estate transfers for taxpayers over $400,000 in income.
- Increase the corporate income tax rate from 21% to 28% or back to 35% if the Tax Cuts and Jobs Act is repealed.
Proposed Transfer and Estate Tax Changes
- Repeal of the TCJA would reduce the exemption from $11.7 million to $5 million. There is speculation that new legislation could reduce the exemption even further, possibly to the $3.5 million level previously proposed by the Obama/Biden administration.
- It is likely that Biden will propose a repeal of the Tax Cuts and Jobs Act, which would lower the exemption back to $5,49million adjusted for inflation since 2018. However, it is more likely that Biden will propose an even larger reduction down to $3,500,000. If this proposal goes through it would bring down the Estate Exemption to $3,500,000 for an individual and $7,000,000 for a married couple (typically these numbers are adjusted for inflation it is possible they will not be). For some folks $7,000,000 estate sounds very high and will not impact you. It is possible that it will not but consider a hypothetical example: John & Jane each retire at the age of 55 with an estate valued at $1,500,000. If they average a 6% return over the next 30 years and pass away at the age of 85, they will have accumulated an estate worth $9,033,863 and taxable up to 45% under Biden’s proposal. This would generate roughly $915,000 in taxes that John and Jane’s beneficiaries would have to pay to settle mom and dad’s estate.
- Eliminate the step-up in tax basis at death. Under current law, appreciated assets included in an estate receive an income tax basis step-up to their date-of-death value or their value six months later.
- When people inherit assets a step-up in basis can provide big tax benefits. Assets passed down in a will, like a home or stocks, generally have gained in value since the deceased purchased them. Consider a hypothetical example: Michelle invested $10,000 in a portfolio of diversified stocks years ago, and the shares are worth $1,000,000 when she passes away. Had she sold the shares before her passing, she would have owed long-term capital gains taxes on $990,000. We reach that number by taking the current value of $1,000,000 and subtracting the cost basis of $10,000. But she did not sell the stocks; she willed it to her son, Mark. If Mark sells the stock when he receives it, he will receive a step-up in basis and the new cost basis would be $1,000,000. He would owe zero capital gains taxes if sold the positions at $1,000,000. If Mark decides to let the account continue to grow, he would only be taxed on the growth above the $1,000,000. If the current administration eliminates the step-up in basis, as they have discussed, this would cost Mark an additional $429,660 in taxes based on the proposed 39.6% plus long-term capital gains rate and the additional 3.8% Affordable Care Tax surcharge for a total of 43.4%. This is just from generation one to generation two imagine the impact on future generations.
- The Obama/Biden administration issued proposed regulations in 2016 that would meaningfully restrict the use of fair market value discounts when assets transferred are subject to lack-of-control, marketability, or other restrictions. These proposed regulations were withdrawn in 2017, but it seems likely some version of them will return under the new administration.
- Impose restrictions on the use of grantor retained annuity trusts (GRATs) and GST trusts.
If you have any concerns about what could happen and would like to sit down with our team to discuss your situation, please reach out as soon as possible as it is possible that we can still make updates to your current plan and get those into effect before any possible future changes.