This election season, like most others, taxes are emerging as a key debate point between the two major parties. While it is still well to early to know who will win we felt it might be helpful to look at what a “new” tax setup might look like under a Biden/Harris administration.
While tax policy changes are not uncommon President Trump oversaw one of the more significant overhauls of the tax code in the last several decades. He did this through the Tax Cuts and Job Act (TCJA). This signature legislation changed items on both the personal and corporate tax codes. If President Trump retains his office it is unlikely there will be further changes to the code.
However, under a Biden win, there are several key areas that are likely to be targets of change.
Increases to Ordinary Income Brackets
There is no question that a great deal of attention is always placed on the top income tax rate paid in the United States. This fascination is interesting as for most Americans it has no impact on their personal tax situation!
Under the Trump plan, the top marginal rate of 39.6% applied for single filers with income above $418,000 and joint filers with a taxable income of $470,000 or more. Under Biden’s plan, he would change that to $400,000 for single and joint filers. This would create a situation where some joint filers would move from 32% all the way up to 39.6% bracket! For those with incomes under $400,000 there would be no changes to the bracket structure which is consistent with his belief of taxing the wealthy and redistributing it down the line.
Elimination of Qualified Business Income (QBI) Tax Deduction
The Biden plan would aim to completely remove one of the major pieces of the Trump administration. The QBI allows for business owners (partnerships, LLCs and S corps) to deduct 20% of their business income from their personal income. This simple deduction functionally lowers these individual’s rates by 20%. For someone in the 10% tax bracket, their new functional rate becomes only 8%. A powerful tool for some.
The removal of this business deduction would only apply to individuals that have crossed the magic $400,000 threshold. The inter-connectedness of this removal combined with the bump in ordinary rates is important to understand. Specifically, for those “higher earners” that move into the new 39.6% rate they will be hit with an additional tax because of the removal of the QBI. In a sense a double-whammy.
Flat Limit on Deductions for Contributions to Retirement Accounts
Another major change in the Biden plan would be to remove the deduction available when contributing to pre-tax retirement accounts. This would be replaced with a credit of 26% in order to eliminate the benefit for higher-earners. For example, someone in the 39.6% bracket would have been eligible for a deduction of that amount on his/her income. Now they would only receive the 26% which would functionally decrease the incentive to save (from a tax perspective).
Conversely, those in lower brackets, say 15%, would gain a benefit by being able to earn a credit of 26% vs. the prior 15%. This effectively boosts the incentive to save by lower-income earners finding “free” money in the difference between their tax rate and the higher credit rate.
This switch may encourage more individuals, especially at higher rates, to pursue other savings opportunities such as through ROTH IRAs or simply via investing more in taxable accounts.
Increase in Capital Gains Tax Rate to Ordinary Income Rate
Another way that Vice President Biden aims to redistribute capital from the “wealthy” to those more in need is via an increase in the capital gains tax. This would apply to any individual/couple with an income of over $1,000,000 a year.
This would move the functional capital gains rate for those in that category to the new maximum income rate of 39.6% plus the 3.6% surtax.
This creates a planning opportunity for families with high incomes and lots of embedded capital gains. For some incurring gains (and even repurchasing the same security after 30 days) in 2020 may be preferable than taking gains under the Biden plan in order to avoid the higher rates. Others may elect to gift shares of low-basis stock to charities and/or future generations with lower incomes.
Elimination of Step-Up-In Basis for Estates & Lowering Estate Tax Limit
Mr. Biden has proposed lowering the estate tax limit for any one individual down from over $11 million to just around $6 million. Additionally, they have proposed eliminating the step-up in basis on any assets inherited by heirs.
The elimination of the step-up in basis has long been an area of focus for increasing tax revenue. However, its application and subsequent approval are difficult to imagine. For example, what happens to the family farm where there are little liquid assets but large physical wealth?
The lowering of the estate limit is something that could be enacted fairly easily but would have major implications for estate plans changed to match the Trump rules. This likely will result in wealthy families rushing to use up their higher-tax exemptions in 2020 in order to lock in the higher limits. FYI – the IRS has already stated they will not attempt to “clawback” money done during old tax codes.
It is much to early to begin making plans already. However, for those under $400,000 in income and/or without sizeable assets little is likely to change. For those in those situations taking time to be aware of your options heading into the end of the year could save you and/or your family significant wealth!