The tax proposals set forth by Biden will likely result in a tax increase for high income individuals, with tax credits and other assistance for lower income individuals. The majority of the proposed legislation will impact individuals with income over $400,000. Biden’s tax proposal includes an increase in the top marginal income tax rate, taxing long term capital gains and qualified dividends at ordinary rates, capping tax benefits for itemized deductions, increased employment taxes, and a phase-out of the qualified business income deduction.
The Trump administration aims to make the tax changes enacted by the 2017 Tax Cuts and Jobs Act (TCJA) permanent, coupled with a reduction in middle class tax rates. The current individual tax rate and other TCJA provisions affecting individuals expire at the end of 2025.
Ordinary, Long Term Capital Gain and Qualified Dividend Tax Rates
Currently, the top income tax rate sits at 37% and is scheduled to revert back to 39.6% at the end of 2025. Biden’s tax proposal looks to accelerate the expiration of the current top rate as early as 2021 (possibly 2022), for individuals with income over $400,000.
Investment income from long term capital gains and qualified dividends are currently taxed at a top rate of 23.8% (20% income tax plus 3.8% net investment income tax). Under the Biden tax proposal, the top long-term capital gain and qualified dividend tax rate would be increased to 43.4% (39.6% income tax + 3.8% net investment income tax) for income above $1 million.
Planning Opportunity: A proposed increase in income and investment taxes may impact an individual’s decision to realize certain items of income in 2020 versus 2021. Taxpayers may want to accelerate bonuses, capital payouts, sales of securities, and sales of business interests or real property before the close of the year.
Planning Opportunity: Taxpayers should be working with their investment and tax advisors to lock in on tax savings prior to year-end, as well as develop a long-term approach to asset allocation based on the possible law changes. Further, individuals that rely on their annual income from qualified dividends and capital gain distributions should review their after-tax cash flow calculations to assess the impact of an additional 19.6% of income tax.
Observation: Election results may impact the value of investments in the last two months of the year.
To learn how Biden’s proposed repeal of the step-up in basis of a decedent’s assets at death may impact heirs, click here.
The number of individuals that itemize deductions has decreased since the enactment of the TCJA, which capped the state, local and property tax deduction at $5,000 ($10,000 for married filing joint (MFJ) taxpayers), removed miscellaneous 2% deductions, and increased the standard deduction to $12,200 for single taxpayers ($24,400 for MFJ taxpayers). Individuals that currently itemize deductions have charitable contributions, mortgage interest expense, and investment interest expense in excess of the standard deduction. Total allowable itemized deductions receive a dollar for dollar deduction against an individual’s adjusted gross income.
The Biden tax proposal seeks to cap the tax benefit of itemized deduction at 28%, for individuals in a 28% or higher tax bracket. This is coupled with the possible removal of the cap on state, local and property tax deductions. Biden would also like to restore the Pease limitation, which reduces itemized deductions by 3% of adjusted gross income in excess of a threshold amount. These tax proposals would apply to individuals with income over $400,000.
Planning Opportunity: Plan ahead to maximize the tax benefits for itemized deductions between 2020 and 2021.
- Charitable contributions scheduled for payment in future years, such as outstanding pledges, may be preferable to accelerate to 2020.Under the CARES Act, the limit on cash charitable deductions to public charities was increased from 60% to 100% of adjusted gross income (AGI) for donations made in 2020. The limit on non-cash contributions to charitable organizations remains unchanged at 30% of AGI.
- Deferring the payments of state and local income taxes, as well as property taxes to January 2021 which may result in a larger deduction in 2021 due to the current cap.
- Paying down current outstanding interest expense on home loans and investment loans prior to the end of the year may also maximize the tax benefit of these deductions.
Phaseout of Qualified Business Income Deduction (QBID)
The QBID was introduced by the TCJA. Individuals with certain types of business income and REIT dividends receive up to a 20% deduction against this income, effectively lowering the top income tax rate on qualified business income to 29.6% (37% * 20%). Biden’s tax proposal would phaseout the QBID for taxpayers with income over $400,000. This would increase the marginal tax rate for affected taxpayers currently eligible for the QBID by 10% (39.6%-29.6%), or about 1/3. To learn more about the QBID’s impact on business owners, click here.
Trusts are taxed similarly to individuals, but with top tax rates kicking in at a much lower threshold ($12,950 of ordinary taxable income). Trusts are eligible for favorable long-term capital gain and qualified dividend rates, are not subject to the Pease limitation on itemized deductions, and are eligible for the QBID. The foregoing Biden tax plan also impacts trusts and many of the planning points and strategies are equally applicable to them.
Increased Employment Taxes
The current employment tax structure includes a 12.4% (6.2% employee share) social security tax on wages up to $137,700, 2.9% Medicare tax on full wages (1.45% employee share and no cap) and a surtax of .9% on wages above $200,000 ($250,000 MFJ). Under the Biden plan, the Social Security tax exemption would be eliminated for wages over $400,000, with no Social Security tax on income between $137,700 and $400,000. The Social Security tax is split between the employee and the employer. To learn more about the impact of additional social security tax on employers and business owners, click here.