With the inauguration of President Biden, as well as the results from the Georgia Senate runoff elections, Democrats now control the presidency as well as both houses of Congress. This makes it more likely that some or all of President Biden’s tax plan will be enacted. Although these changes are still far from certain — Democrats hold only a slim margin in the Senate — we thought now would be a good time to review the major parts of President Biden’s plan and explain what it might mean to your bottom line.
Change in Top Tax Rates
Perhaps the most immediate change would be the rollback of top tax rates enacted with the TCJA (Tax Cuts & Jobs Act) in 2017. TCJA lowered the top ordinary tax bracket from 39.6% to 37%. The new tax proposal would raise the rate on top earners, back to 39.6%. It would also lower the top tax bracket to include those making $400,000 or more. (The current top tax bracket does not start until $628,300 for joint filers.)
Most of the language in Biden’s plan is directed at those making $400,000 or greater, and this seems to be the hard line that he has drawn. Taxpayers with incomes below $400,000 should not see a change to their brackets or rates. It is important to note that this part of the TCJA was already set to sunset in 2026. Biden’s plan just accelerates this timeline.
Cap on the Value of Itemized Deductions
Itemized deductions have long been a strategy to help high earners lower their effective tax rate. For taxpayers in the 10%, 12%, 22%, and 24% tax brackets, Biden’s proposal would have no impact. For the higher brackets, it would limit the tax benefit to 28%. Taxpayers with substantial deductions would see their effective tax rate increase. For instance, someone in the 39.6% tax bracket under the proposed cap of 28%, who donates $10,000 to charity, would receive a tax benefit from the deduction in the amount of $2,800 ($10,000 x 28% = $2,800). Without this new cap on the tax benefit, the deduction on that same $10,000 would yield a tax benefit of $3,960 ($10,000 x 39.6% = $3,960). This is an increase in tax liability of $1,160 for the same $10,000 donation ($3,960 -$2,800 = $1,160).
Change in the Tax Benefit of Retirement Plan Contributions
Perhaps the biggest tax planning challenge and opportunity for most people will come in the form of a complete revamp of the tax effect of retirement plan contributions. The current system of allowing above-the-line deductions for certain retirement plan contributions disproportionally favors high income earners. Biden’s plan would help rectify this inequality. He proposes to eliminate the deduction for retirement plan contributions and instead implement a flat 26% credit for all contributions. This plan would increase the effective tax rate for those in the 32% and greater income tax bracket and lower the effective tax rate for those in the 24% and below tax bracket. His goal is to entice lower income earners to save more for retirement. This plan could make the use of ROTH type accounts more valuable for higher income earners and less so for the lower brackets.
Increase in the Long-Term Capital Gains Rates for Ultra- Higher Earners
The biggest effect that Biden’s proposal has on investments would be the change of long-term capital gains rates for income exceeding $1,000,000. His plan would increase the long-term capital gains rate (currently 20%) to equal the ordinary income tax rates (39.6%) in amounts that exceed $1,000,000. If total income is under $1,000,000, the current tax treatment remains. It is also important to point out that the increase to the tax rate would only be on dollars in excess of $1,000,000. For instance, if someone had $950,000 of ordinary income and $150,000 of long-term capital gains, only $100,000 of the long-term capital gain would be subject to ordinary income tax rates. For individuals that this new tax might affect, careful planning and timing of when capital gains are realized will become more important going forward.
Elimination of the Step-Up in Tax Basis Rule
The biggest change in estate planning under Biden’s proposal could be the elimination of the step-up in tax basis that certain assets receive on the death of the original owner. Under the current system, when someone passes away, the law states (with some exceptions) that the tax basis of property inherited from the decedent shall be the fair market value of the property at the date of the decedent’s death. This typically allows for any unrealized gains that are embedded in the asset to be essentially wiped clean. Under Biden’s proposed plan, this step-up feature would essentially go away, and the assets will be deemed sold for tax purposes on the date of death. This will create a tax liability for the estate and potentially create liquidity issues as well. It is unclear how Biden would implement or enforce such a plan.
Good News for Taxpayers in Lower- and Middle-Income Levels
Biden’s proposal is not all bad news. In addition to the credit for retirement account funding, which will help those making less than $300,000, the following credits have also been discussed:
- Child Tax Credit – The current credit of $2,000 per child under age 17 would be increased to $3,600 for children under age 6 and $3,000 for all other children under age 17.
- Child and Dependent Care Credit – The current credit of a maximum of $3,000 for one child and $6,000 for two or more children would be expanded to a refundable credit of $8,000 for one child, and a whopping $16,000 credit for two or more children.
- First-time Homebuyer Credit – While specifics surrounding the credit have not yet been made public, a new refundable and advanceable credit of up to $15,000 would most likely mirror the first-time homebuyer credit first introduced during the (George W.) Bush administration in 2008 and later expanded by the Obama administration in 2009. In both situations, the maximum credit was capped at 10% of the purchase price of the home.
- Caregiver Credit – A new credit of up to $5,000 would be created to assist individuals who provide informal care to those in need of long-term care. Additionally, President Biden’s plan calls for enhancing the current tax breaks associated with the purchase of long-term care insurance, though how exactly that would be done is not entirely clear.
As with any change in political party control of government, we should expect discussion of tax law changes, though they are just discussions at this point. Congress still has a lot to deal with around the pandemic and its long-term effects on the economy before they tackle major tax reform. Increasing taxes during a recession is also at odds with any sort of fiscal stimulus that Congress is pushing to help stabilize the economy.
Also, Biden’s proposed tax plan calls for major changes in some key areas of tax law, and it is unlikely that all elements of the proposed plan will be approved. Although Democrats have control, it is unlikely that Biden will have carte blanche with his policies.
As always, we will monitor things as they progress, and if you have any questions about anything covered in this article, please reach out to your Telarray Advisor. Thank you, as always, for your trust in us.