Oct 07, 2020
Biden’s Tax Proposal
From a global pandemic, to numerous conspiracy theories, abrasive and negative TV ads, along with the strong influence of social media, we can probably agree that the 2020 election has been the most dramatic election season ever. The likelihood of these factors diminishing before the election are thin, so it is crucial that you use trustworthy sources before hitting the polls.
As we approach the general election, we are using this opportunity to present Joe Biden’s tax proposal. As a reminder, it is just that…. a proposal. Since this proposal serves as informational, this does not mean you need to make any sort of action just yet. Making any major changes now, based on an election, and based on a tax proposal is very risky -- we strongly suggest waiting and watching.
When would these changes be made?
The current tax law was put into effect by the 2017 Tax Cuts and Jobs Act when President Trump took office. Overall, about 65% of households paid less in individual income taxes in 2018 as a result of the TCJA, and about 6% paid more. The rest paid approximately the same amount.
The answer to when this proposal could go into effect is unknown. It depends on what happens in Congress and who holds the majority. If the Democrats win the majority, they could pass the bill in 2021 and have it retroactively applied to 2021, meaning this could possibly be the last year with current tax rates.
Big Picture Results
This blog post summarizes an article written by the Committee for a Responsible Federal Budget [http://www.crfb.org/papers/und... ]. Most elements of the plan have been made by estimators - the Tax Policy Center (TPC), Penn Wharton Budget Model (PQBM), Tax Foundation (TF), and American Enterprise Institute (AEI).
Overall, there is a projection to raise a total of $3.35-$3.67T over the next decade from this proposal—about $1.5T coming from corporations, a little over $1T coming from high earners, and about $1T coming from SS payroll tax on high earners.
Impact on $400k+ Earners
In this blog post, we are going to discuss the impact on those defined as high earners ($400k+) according the proposal.
Lower QBI Phaseout
Currently, if you have income from partnerships, S Corps, and/or Sole Props, it is probably Qualified Business Income and you might be eligible for the 20% QBI deduction. Under Biden’s proposal, those making under $400k per year would maintain the current deduction, while completely phasing out the deduction for those making over $400k.
Repeal TCJA Tax Rates
Currently, individuals making over $207k and couples making over $415k are subject to a 35% marginal income tax rate; individuals making over $518k and couples making over $622k are subject to a 37% top rate. After the current TCJA sunsets in 2026, the top tax rate will revert back to the 39.6%. Biden would likely restore that rate immediately, instead of waiting for the sunset to occur.
Cap Value of Itemized Deductions
Only one-tenth of taxpayers itemizes their deductions, instead of taking the standard deduction, but more than half of the taxpayers in the top income tax bracket itemize. For example, with this new cap of 28%, individuals in the newly restored 39.6% tax bracket would only receive a maximum 28-cent tax reduction for every dollar spent on charitable giving.
Tax Capital Gains as Ordinary Income
Under current law, income from the sale of assets held long term is taxed at a top rate of 20% (plus 3.8% surtax). The proposal includes individuals and couples making over $1M taxed at their new ordinary income rate of 39.6% (plus a 3.8% surtax). This would essentially add an extra tax bracket for capital gains [0%, 15%, 20%, 39.6%]
Eliminate Step-up in Bases OR Make a Death Realization Event…or maybe both
There is still some unknown with this proposal, but if either of these are established this will tremendously impact tax and estate planning. Eliminating step-up in basis for heirs would likely mean a large tax bill when they dispose of the assets. If there is a taxation on the unrealized gain at death, it will likely be on the higher earners, using either the $400k or the $1M threshold.
Reduce Gift, Estate and GST Exemptions
Another impactful estate change would be reducing the currently high exemption amount of $11.58M. Biden would likely cut that in half and revert to the pre-TCJA exemption amount of a little over $5M.
Full 12.4% OASDI on Wage Earnings Above $400k
Currently, earnings above the annual taxable- maximum $137,700 in 2020 are not subject to payroll tax. With the proposal, this would continue until $400k. At that point, you would incur the full 12.4% OASDI tax, but you would not receive any additional Social Security benefits. This creates a donut hole, and overtime this donut hole would disappear and all earnings would be subject to the payroll tax. The reason for this is that the annual taxable maximum would grow with average wage growth, while the $400k threshold would remain fixed, causing the donut hole to disappear once the annual taxable maximum reaches $400k.
Effect on the 99%
Overall, the tax proposal is projected to increase taxes for the top one-fifth of earners by 2.3 to 5.7% of after-tax income in 2021. The majority of individuals will face a tax increase of .2 to .6% of after-tax income and most of this increase is due to the increasing of corporate tax rates.
What’s to come:
Our subsequent blog posts will include further details on the individuals and couples making under $400k, along with discussion on proposed tax credits and the proposal’s impact on businesses.
Financial Planning Associate
Melissa came to Narwhal in the summer of 2018 following the completion of her master’s degree in financial planning from the University of Georgia, where she also earned her bachelor’s degree in consumer economics. Her interest in the field started with learning about consumer behavior, specifically it’s relation with complex moneymaking decisions. Melissa recently passed the CFP® examination in March 2020 and is currently fulfilling her experience requirement to become certified by March 2021. When she’s not working, Melissa enjoys doing pro-bono work, running (to an extent), reading, yoga, and spending time with her niece.
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