As a presidential candidate, Joe Biden laid out more than $3 trillion of tax increases to pay for an agenda ranging from expanding health care to fighting climate change. Now that the Democrats will control both houses of Congress and the White House, it’s time to focus on tax law changes they might propose. Although President-elect Joe Biden and other Democrats have proposed many changes to individual income and payroll taxes, business income taxes and individual transfer taxes, we’ll limit this commentary to those changes that would be most likely to affect our clients and are attributable to President-elect Biden.
The Riverview team has created the following summary to help you understand how the President’s tax program, which is expected to raise taxes on corporations and individuals earning more than $400,000 in adjusted gross income, could impact your finances. Bear in mind that any legislation emerging from Washington’s political crosscurrents may look very different from what Biden has proposed.
Biden has proposed increasing the federal tax rate on ordinary income for individuals with more than $400,000 of annual adjusted gross income. The current top federal tax rate, 37%, would increase to 39.6%. There’s one big unknown: whether the $400,000 income threshold would apply to single or joint filers.
Biden wants to treat long-term capital gains and qualified dividends as ordinary income for those with an annual income exceeding $1 million. If he’s successful, individuals earning more than $1 million will pay a rate of 39.6%, or nearly double the current 20%. Including the 3.8% net investment income surtax—the “Obamacare tax”—the effective rate on the wealthiest investors could total 43.4%.
Biden’s plan caps the tax benefit of itemized deductions at 28% for higher-income taxpayers. This means that each dollar of itemized deductions would only decrease your total income-tax liability by 28 cents. Currently, there is no cap, meaning deductions for things like charitable contributions and mortgage interest expenses are as high as 37%. The President also wants to restore the so-called Pease limitation, which incrementally reduces itemized deductions based on income levels; the highest-income taxpayers could lose 80% of their itemized deductions.
Biden favors the repeal of the current $10,000 cap on deductions of state and local taxes. The limit disproportionately burdens those in high-tax states such as New York and California.
Currently, wages and self-employment income up to $142,800 are subject to a 12.4% Social Security (FICA) tax. Under Biden’s plan, the tax would also be imposed on income over $400,000. The income between $142,800 (for 2021) and $400,000 would be free of the tax.
Very wealthy households could face a double whammy here: Biden wants to slash the unified federal gift and estate tax exemption while raising the tax rate. Individuals can currently transfer as much as $11.7 million, and couples can transfer up to $23.4 million, tax-free. The exemption level could be lowered to $5 million per individual, or conceivably to the $3.5 million once proposed by the Obama administration. Even if lawmakers were to ignore estate and gift taxes, the exclusion amount will revert to $5 million (inflation-indexed) when the current level expires at the end of 2025. The gift and estate tax rate currently stands at 40% but was 55% as recently as 2001.
Biden wants to do away with the step-up in the cost basis of appreciated assets transferred to heirs. Currently, assets are valued as of the date of death, eliminating unrealized capital gains for tax purposes. Biden’s proposal would recognize and tax those gains.
Biden’s tax plan would eliminate certain favorable tax treatments that apply to real estate. Most notable are IRS Section 1031 exchanges, which allow owners to swap an appreciated property for another without paying federal income tax.
The President would increase the corporate tax rate from its current 21% to 28%. The added tax burden could conceivably filter into companies’ earnings and thus their stock prices.
Biden has also proposed several middle-class tax cuts, including incentives for first-time homebuyers and an expansion of the child tax credit to $3,000 from $2,000.
It’s a good bet that any tax increases will be tempered by legislative compromise. Democrats control Washington by a very thin margin. The November election shrank their House majority, and the party holds a Senate edge only by Vice President Kamala Harris’s tie-breaking vote. Considerable horse trading will likely be needed to get bills passed.
Furthermore, the timeline for tax legislation is uncertain. With Washington managing a pandemic, a deep economic crisis, and a potential impeachment trial simultaneously, tax legislation might have to wait. Keep in mind, though, that tax changes passed later in 2021 could be made retroactive to the beginning of the year. Or the tax legislation changes could be designed to take effect next year when the economy might be on a firmer footing.
So what actions should you take to protect your wealth? First, do no harm. Engaging in drastic measures will prove to be a mistake if the tax landscape becomes different from what you expect. We recommend that you meet with your tax professional to create game plans based on different legislative outcomes. Check in with your financial advisor to make sure your investment portfolio is well diversified from a tax standpoint. As future tax laws become more apparent, you’ll be prepared.
Riverview Trust Company investments are not insured or guaranteed by the Bank, the Federal Deposit Insurance Corporation or any other government agency. Non-deposit products are subject to investment risks, including possible loss of principal. Past performance does not indicate future results. Asset allocation does not assure or guarantee better performance and cannot eliminate the risk of investment losses.
Riverview Trust Company does not provide tax or legal advice. The information presented here is not specific to any individual's personal circumstances. To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances.
These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable—we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice.
Kamin, Kim (2021, January 14), A Guide To Potential Tax Law Changes Under Biden, Wealthmanagement.com.