Summarized below is what we currently know about Biden’s proposed tax changes. As I have said to many clients, we can’t control the rules of the game, but once we learn what the chess board looks like, we will work hard to determine the best way to move the pieces and protect your money. We always find a way!
Current Tax Law
Proposed Tax Plan
37% highest ordinary individual income tax rate
Raise back to 39.6%
6.2% Social Security tax is paid on the first $137,700 of wages
6.2% Social Security tax applied to all earnings for those earning more than $400,000
20% highest capital gains rate
39.6% capital gains rate for those with incomes greater than $1,000,000
20% Qualified Business Income deduction with no income limit
Eliminated for those with incomes greater than $400,000
$10,000 max itemized deduction for combination of property taxes and state/local income taxes
Reinstate the reduction of a taxpayer's overall itemized deductions when income exceeds $400,000
Tax free "step up" in basis of assets at death
“Step up” eliminated, cost basis passes to heir
Estate tax exemption of $11,580,000 per person and maximum tax rate of 40%
Estate tax exemption of $3,500,000 per person and the maximum tax rate back up to 45%
Corporate income tax rate of 21%
Increase the corporate income tax rate to 28%
Child Tax Credit of $2,000 per child regardless of age
Child Tax Credit increased to $3,000 per child (ages 6-17) and $3,600 (children under 6)
Expand the Child and Dependent Credit to allow for up to an $8,000 credit for low and middle class families
New first-time homebuyer tax credit of up to $15,000 advanceable at time of purchase
And since it is likely top of mind, one big issue for investors will be when we expect these tax changes to start. Some investors fear they would be retroactive to January 1, 2021, but with unemployment rates still high and recovery slowed by COVID-19, we think they will more likely be delayed until January 1, 2022.
President Biden will have a slight majority advantage in both the House and Senate, so getting some of these changes is likely a reality. Getting all of them passed, is not likely. In 2017, President Trump passed the largest tax reform since 1986, but it took him nearly 2 years to do it – with many revisions along the way.
The following commentary on the proposed changes comes from Brian Wesbury, the Chief Economist of First Trust. I was going to write my own, but he does a pretty good job of putting some reality around the situation and makes some estimates as to what we can expect. That said, no one has a crystal ball, and we will have to see how this plays out. As always, we will keep you updated every step of the way.
“So what will the Democrats do? First, it is almost certain the top tax rate on regular income will head back to 39.6%. Second, the corporate tax rate, which was 35% for a generation before President Trump and cut to 21% for the past few years, will likely be lifted to 28%. Neither of these moves will help the economy grow, but the US had a top personal tax rate of 39.6% and a corporate tax rate of 35% from 1993 to 2000 and 2013-17, with no recession during any of those years.
Third, the limit on state and local tax deductions is likely to double from its current $10,000 to at least $20,000.
After this, it gets a little trickier. The Biden campaign proposed eliminating the step-up basis at death for inherited assets. But doing so would make many CPAs and tax accountants around the country scream. Some people have no idea what their parents or grandparents paid for an asset and finding out would be an administrative nightmare. Instead, look for Congress to put a lower limit on what can be passed on tax-free to heirs. We expect the estate tax exemption amount to fall to $6 - 7 million versus $11.6 million in 2020.
The Biden campaign has also proposed treating capital gains and dividends as regular income for those earning $1 million plus. But a 39.6% rate on this income (which is really a double tax) would push rates to levels we haven't seen since the Carter Administration. Slender majorities should make this virtually impossible. Instead, look for a tax rate hike to 24% from 20%, at present. Why 24%? Because, combined with a 3.8% Medicare tax, the effective federal rate would be close to 28%, which is where it was when President Reagan left office in 1989. Optics matter and we could see Biden arguing that he'd be raising these rates no higher than where they were under Reagan.
The one big proposal that will likely fail is applying the Social Security tax to earned income above $400,000. Changes to Social Security benefits or taxes can't be done through budget reconciliation and raising the tax won't have the 60 Senate votes needed to break a filibuster.”
Nick Kolbenschlag - Chief Executive Officer & Co-Founder