1. More Taxes on High Earners
A “high earner” in this case would be any household with an annual income of $400,000 or more. The expectation would be that the old top marginal tax rate of 39.6% would be restored. (The TJCA lowered it to 35% back in 2017.)
In addition, Biden has also floated the idea of adding an additional 6.2% Social Security tax for any income over $400,000. Currently, Social Security is funded by a 12.4% tax on earnings up to $137,000, with half the tax being paid by employees and half being paid by employers.
One more way that high earners will be affected is a potential limitation on itemized deductions. There has been some talk that the Pease limitations would be reinstituted under Biden. The tax benefit of itemized deductions would be limited to 28%, affecting anyone in tax brackets above that amount.
Finally, it’s rumored that the Biden administration is considering the elimination of preferential tax treatment for long-term capital gains and qualified dividends for people who earn more than $1 million. I find this interesting since this would effectively eliminate the carried interest loophole. This would also directly affect the political donor class, so I’ll be shocked if this is actually one of the tax changes under President Biden that is implemented.
2. Estate Tax Changes
While there is some debate on where the estate and gift tax exclusions will end up, the general consensus is that they will be greatly reduced.
Currently, each American can pass $11.7 million to heirs before owing any estate taxes. The Biden administration has stated that they would like to reduce those limits to 2009 levels, cutting the estate tax-free amount to $3.5 million per individual.
It would also increase the estate tax rate from 40% to 45%. That’s a pretty big deal. Many more people will have to be concerned about estate tax planning if these changes take place.
Eliminating the Step-Up in Cost Basis is another potential change in estate tax law.
While federal estate taxes do not affect many Americans, there is one proposed change in estate tax law that would: the elimination of the step-up in cost basis at death.
What is the step-up in basis? Here’s an example:
Let’s say that, years ago, your rich uncle bought $10,000 of stock in ABC Company. Since then, the value of those shares has grown to $100,000. Sadly, your rich uncle passes away. However, much to your delight, you discover that he bequeaths the ABC shares to you in his will.
This is where things get interesting.
Because of the step-up in cost basis rules, your cost basis after inheriting the ABC shares “steps up” to $100,000, the current market value of the shares.
Let’s say you decide to sell your ABC shares.
With the current rules, you would owe no capital gains taxes. Your “gain” would be $0 ($100,000 sale proceeds minus your $100,000 cost basis = $0 gain.)
Without the step-up in basis at death, you would inherit your uncle’s cost basis, $10,000. In this case, you would owe capital gains taxes on $90,000 in gains. ($100,000 sale proceeds minus your $10,000 cost basis = $90,000 gain.)
If your capital gains tax rate is 21% (15% for federal and 6% for state), you would now owe $18,900 in taxes. Your inherited stock is now worth $81,100 instead of $100,000.
Should the Biden administration choose to eliminate the step-up in cost basis rules, I think it would affect many more Americans than most people realize. It could potentially create extreme tax liabilities in the case of illiquid assets such as real estate.
3. Retirement Plan Contribution Changes
In what may be the most radical of the potential tax changes under President Biden, some administration officials have proposed to change the tax treatment of retirement savings. Under current law, any savings into a qualified retirement plan are tax-deductible. It creates an incentive to save by reducing your taxes.
However, officials within the Biden administration have stated that this incentive disproportionately favors people with higher incomes. For example, someone in the 35% tax bracket gets a much bigger deduction than someone in the 10% tax bracket.
They want to “equalize” retirement savings by simply offering a tax credit of $0.26 for every dollar saved. This would create a larger benefit for those in the 24% tax bracket and below and reduce the tax benefit for higher-income individuals (those in the 32% tax bracket and above).
These changes, while seemingly simple, would completely change how we save for retirement. Will it be enough to encourage more people to save for retirement?
4. Higher Corporate Taxes
Businesses can expect a few tax changes under the Biden administration, including an increase in the corporate tax rate from 21% to 28%.
There’s also a proposal under consideration that would institute an alternative minimum tax on businesses that have profits of $100 million or more. They would pay either their normal corporate taxes or a 15% minimum tax, whichever is greater.
Unlikely To Happen: Annual Wealth Tax
Finally, one idea that’s been floated by the new administration is an annual wealth tax. What would the annual wealth look like? It would be a tax of 2% of the net worth of anyone with a net worth over $50 million. For those with a net worth of over $1 billion, there would be an additional annual tax of 1%.
Think about that for a second. If you’re a billionaire, you’d owe (at least) $30 million to the government every year in wealth taxes. That’s in addition to your income taxes.
Back in the 1970s, a wealth tax was considered but was thought to be impossible to implement because of the difficulty in calculating net worth. It’s simply hard to determine real-time pricing on certain items like land or collectibles. While much has changed since the 1970s, a wealth tax would still be a complicated undertaking in 2021.
Politicians need campaign donors, so I don’t see this change actually being implemented. However, we’ve seen no shortage of strange events over the last year.
Conclusion: Tax Changes Under President Biden
Unsurprisingly, it seems that we can expect higher taxes based upon the comments of President Biden and officials within his administration. Whether or not they will actually implement some of the more progressive elements of their proposals is yet to be seen.
If you’re concerned about how any of these new tax policies could affect you, then click here to set up a quick, complimentary introduction call to see if Prana Wealth is a good fit. We do still have the capacity to take on new clients.
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