Over the weekend, Vice President Joe Biden and his running mate, Kamala Harris, were declared the 2020 Presidential Election winners. Since Vice President Biden has been declared the winner of the 2020 Presidential Election, I wanted to inform you of some of the potentially significant tax changes that may be coming our way. I will discuss Biden’s proposals for tax bracket changes, QBI deduction for business owners, itemized deductions, retirement contributions, personal income tax credits, long-term capital gains taxes, 1031 exchange, and estate and gift taxes. Please keep in mind that these are the changes he has proposed and will still have to pass through Congress, so these potential changes are subject to change and/or may not get passed. This blog post is intended to bring you up to speed to be aware of the tax changes that we could potentially see. A recurring theme that you will see with Biden’s tax plan is reducing tax benefits available to the high-income families and increased tax benefits for lower-income families. The idea is for the wealthy to pay more in taxes. Let’s start with the current marginal tax brackets.
Tax Brackets
Before diving into Biden’s tax plan for changes to the tax brackets, I want to provide a table with the current marginal tax brackets. From the table below, you will notice that the highest tax bracket is taxed at a rate of 37% if you file single and make over $518,400, if you file married filing jointly and make over $622,050, and if you file head of household and make over $518,400.
Biden’s tax plan is to tax those that make $400,000 or more at 39.6%. It is unclear if this will be for Single, Married Filing Jointly, and/or Head of Household taxpayers. However, the table below shows Biden’s tax brackets’ representation based on the information we know, assuming the $400,000 is across the board for all taxpayers. Notably, the current tax rates are set to “sunset” back to the tax rates before the Tax Cuts and Jobs Act of 2017 in 2026. However, Biden’s plan to increase the marginal tax rates on those making over $400,000 or more would take effect in 2021.
As you can see from the table above, without knowing Biden’s tax plan’s exact details, based on what we do know, the 35% marginal tax rate for Married Filing Jointly could no longer exist. However, those that make less than $400,000 will not see a change in their marginal tax bracket rates. It is not yet known why Biden has chosen $400,000 as the income level; however, he uses $400,000 as a threshold for who should be responsible for picking up more of the overall tax burden.
QBI (Qualified Business Income) Tax Deduction
For those who have not heard of the QBI Deduction, the QBI Deduction was an added tax benefit for business owners, created with the Tax Cuts and Jobs Act of 2017. This deduction provides business owners with the ability to deduct 20% of their business income from their business income, such that they are only taxed on the remaining 80% of their income. High-earning business owners of Specified Service Trades or Businesses (includes doctors, lawyers, athletes, accountants, and financial advisors, to name a few) see their QBI deductions completely phased out once their taxable income exceeds $426,600 for Married Filing Jointly taxpayers ($213,300 for single taxpayers).
Biden’s tax plan would eliminate the QBI Deduction for anyone that makes over $400,000/year, regardless of whether or not their business was a Specified Service Trade or Business. In the past, the QBI phase-outs have typically been determined based on an individual’s own tax return, even if one or multiple businesses all stayed under the $400,000 threshold; as long as the business owner’s income reaches or exceeds the threshold, the QBI deduction would be lost. It could be assumed that this would continue in Biden’s tax plan. Also, the QBI deduction is currently lost if the threshold were exceeded by non-business income, so it could be assumed that this would stay the same in Biden’s plan.
Biden’s QBI deduction proposal is significant to business owners because if you’re making over $400,000, not only will you be in a 2.6% higher tax bracket, you will not be able to lower your taxable income by the potential 20% deduction.
For example, if your business is not a Specified Service Trade or Business and you make $450,000, in the past, you’d get a potential $90,000 (20% of $450,000) deduction lowering your taxable income to $360,000. Moving you from the 35% bracket to the 32% bracket, if you were filing Married Filing Jointly. With the Biden tax plan, you would not qualify for the QBI deduction since your income is above $400,000.
Itemized Deductions
Biden’s tax plan proposes that the value of itemized deductions be capped at no more than 28%. The cap on itemized deductions that Biden is offering is a similar proposal to one that was from the Obama administration. This proposal would not have much effect on taxpayers in the 10%, 12%, 22%, and 24% marginal tax bracket; on the other hand, taxpayers in the 32%, 35%, and 37% marginal tax brackets, could see a considerable increase in their effective tax rate.
Retirement Contributions
Biden’s tax plan would implement a flat credit to replace deductions for contributions to IRAs, 401(k)s, 403(b)s, and similar accounts. It is not known what that credit amount will be; however, experts suggest that a 26% credit would cause no change to tax revenue generated from these allowed deductions (from the Tax Policy Center). Biden’s reasoning for this is to enable lower-income earners to benefit from contributions to pre-tax retirement accounts since higher-income earners have always benefited from making contributions in the past.
Let’s look at an example of how retirement contributions work under the current tax structure and how they will look under Biden’s proposed tax plan. A high-income earner (37% marginal tax bracket) contributes $10,000 to a 401(k) plan and a low-income earner (12% marginal tax bracket) contributes $10,000 to a 401(k) plan.
As you can see from the table above, under the current tax structure, the low-income earner does not have much incentive to contribute to a pre-tax retirement account, while a high-income earner does. Under the Biden proposed tax structure, the low-income earner has more incentive to contribute to a pre-tax retirement account; however, this structure does lower the high-income earner’s tax savings.
Personal Income Tax Credits
Biden’s tax plan offers some new personal income tax credits and expands upon some of the current personal income tax credits. These new and expandable personal income tax credits are aimed at lower- and middle-income households.
For those that do not know what a refundable credit is, it is a credit that you could receive in the form of a tax refund if your refundable credits are more than your tax liability.
Long-term Capital Gains
Biden’s tax plan proposes that if your income exceeds $1,000,000, you will pay ordinary income on any long-term capital gains. For example, if you have $950,000 in earning and have long-term capital gains of $150,000 for a total of $1,100,000. The $100,000 over the $1,000,000 will be taxed at ordinary income, and the $50,000 will be taxed at standard long-term capital gains tax of 23.8%. Under the current tax structure, there is no cap.
1031 Exchange
Biden’s tax plan is looking to eliminate a taxpayer’s ability to use a 1031 exchange if their income exceeds $400,000. Therefore, if your income is over $400,000 and you initiate a 1031 exchange, this will be a taxable event. For those that are not familiar with a 1031 exchange, this tax law allows a taxpayer to “swap” tangible property held for investment with a similar property without initiating a tax bill.
Estate & Gift Tax
Biden’s tax plan is proposing a reduction in the estate and gift tax exclusion from the current $11,580,000 per person ($23,160,000 per married couple) to roughly $6,000,000 per person ($12,000,000). This decision to lower the estate and gift tax exclusion is due to more people having a net worth at $6,000,000 per person ($12,000,000 per married couple) than there are individuals with $11,580,000 net worth (or couples with a net worth of $23,160,000).
Biden is also proposing the elimination of the step-up in cost basis when an individual passes away. If you are unaware, typically, when someone passes away, the decedent’s account’s beneficiary will receive a step-up in the cost basis to the market price on the date the decedent passed away. The step-up is important because it lowers the beneficiaries’ tax burden if they withdraw the funds once they’ve received it. This has been proposed in the past; however, it may be difficult to pass this. Since tracking a fund’s or stock’s cost basis wasn’t expected of the financial institutions until 2011, account holders were required to keep track of the cost basis. If you’re one who doesn’t know what’s going on with your finances, you’re probably not even tracking your cost based on stocks or funds you own. This would make it difficult for financial institutions to track down the cost basis of funds before 2011.
As previously mentioned, from the significant changes that Biden’s tax plan is proposing, it is clear that he wants to push more of the tax burden on the higher income earning taxpayers. Again, keep in mind that these are some of the significant changes to the current tax laws that Biden is proposing, and they first have to go through Congress to be passed. Therefore, none, some, or all of these proposed tax laws may go into effect. If you are currently a high-income earner and not working with a financial planner, the time to start planning is now, and I encourage you to reach out to a fee-only financial planner to assist you. If you are currently a lower-income earner and not working with a financial planner, you too should start planning now because you may have tax benefits that weren’t available to you in the past that you now have access to. I welcome the opportunity to help either if you’re a young professional, family, or entrepreneur that doesn’t have the time to deal with their finances daily. My job is to be your accountability partner to help guide you through times like these.
Sincerely,
Travis Tracy, CFP®, EA