Planning for Biden’s Tax Increases
Candidate Joe Biden proposed income and estate tax reform that would change the status quo in a number of significant ways, which are explained later in this Article. These proposals have missed the rash of “executive orders” issued in the past few weeks since they will require legislative action.
This article addresses the key aspects of Biden’s tax proposal, when these changes will occur, and what can be done to plan for them.
The key aspects of Biden’s tax proposal are as follows:
Individuals
The top marginal rate for individuals would increase from 37.0% to 39.6%.
For individuals with income over $400,000, itemized deductions would be capped at 28.0% of the taxpayer’s income.
For individuals with income over $1 million, taxes on long-term gains and qualified dividends would increase from 20.0% to 39.6%.
The Social Security payroll tax of 12.4%, which currently applies only to income less than $137,000, would also apply to income over $400,000. It should be noted that the Social Security payroll tax is split evenly between the employer and the employee.
Businesses
The corporate tax rate would increase from 21.0% to 28.0%.
An alternate minimum tax of at least 15.0% would be imposed on companies with profits of $100 million and more.
The global intangible low-tax income (GILTI) rate would increase from 10.5% to 21.0%.
The qualified business income deduction (i.e., Section 199A) would be phased out for filers with taxable income over $400,000. Section 199A, which is utilized for rental real estate activities, provides many owners of sole proprietorships, partnerships, S corporations, and some trusts and estates, a deduction of income from a qualified trade or business. Currently, self-employment and flow-through business income are entitled to a deduction of up to 20% of net business profits.
Although it is not a part of his plan, Biden has implied that he might seek to eliminate Section 1031 “like-kind” exchanges. A Section 1031 exchange is a swap of one investment property for another with no or limited taxes due at the time of the exchange. It allows an investment to continue to grow tax-deferred.
Estates and Gifts
The estate and gift tax would increase to up to 45.0% from the current progressive rate scale that tops out at 40.0%.
The estate and gift tax exemption level would revert back to its “historical norm.” While it is not clear exactly what the “historical norm” means, it is thought to possibly be the Obama-era exemptions of $5.49 million for individuals and $10.98 million for married couples. The current estate and gift tax exemption is $11.58 million for individuals and $23.6 million for married couples.
The elimination of step-up in basis for inherited assets of estates. Current tax law allows for a stepped-up basis at date of death, which results in beneficiaries receiving an appreciated asset that is not subjected to a capital gains tax. According to the Tax Foundation, the elimination of step-up in basis for inherited assets would almost exclusively affect taxpayers in the top 20% bracket, with a distributional effect almost four times larger for those in the top 1% bracket relative to those in the top 20% bracket.
When are these changes likely to occur?
Many experts, economists, and influential politicians have indicated that future tax cuts will not be implemented until the economy stabilizes, as reflected in the following statements:
Ben Harris, a top economic advisor to Biden, stated, “If any of these tax initiatives are found to be economically damaging at this point during this fragile recovery, they’re not going to be part of the plan.”
Jared Bernstein, another economic advisor to Biden, stated that any tax increases will be “very dependent on economic conditions.”
Senator Richard Blumenthal stated, “A tax bill can be made effective at a time when we think the economy will be sufficiently robust that some increase in taxes will have no detrimental effect.”
Dan Weiner of newsletter “The Independent Adviser for Vanguard Investors” believes that major tax changes are unlikely in 2021, “It’s very unlikely they will try to force a big corporate tax hike this year.”
George Mateyo, chief investment officer at Key Private Bank, weighed in with “Any president will have a difficult time raising taxes right away in the middle of a pandemic. I don’t want people to overreact. I think they may be delayed.”
Even if the Biden tax plan is pushed early on in his administration, it is unlikely that changes will be implemented until sometime in 2022. For some perspective, even with a Republican Congress it took President Trump one year in office to pass the Tax Cut and Jobs Act. And history shows that retroactive tax increases are rare.
What can you do in the interim to plan for these tax increases?
As it pertains to estate planning, it may be a good time to make gifts before changes are made to the tax code.
If you are planning to sell a company sometime in the future, it might be a good idea to consider selling it before taxes go up. This could be especially true for owners of pass-through entities that are worth more than $1 million. However, if the effects of COVID-19 have significantly and adversely affected your company’s value, then selling it in the near term may not be advisable.
If you hold stock options, it may be beneficial to exercise the options before changes are made to the tax code.
If your company has the ability to accelerate income and defer expenses, then it might be advisable to do so. For example, if you can push income into 2021 and/or if you don’t take bonus depreciation in 2021, more depreciation would be pushed to years when tax rates are higher.
If you would like more information on how these tax changes will affect you, your family and your business, or you would like to know what you can do to prepare for these tax changes, consult with the seasoned tax professionals at Lauer Law, P.A. today!