With Joe Biden’s presidency all but official certifications away, a hard look at his tax plan should be done between now and the end of 2020. Certainly, no one can predict whether this plan or any parts of it could be passed into law during 2021. The Georgia senatorial race slated for a run-off in January will play a major role as the fate of which party controls the senate rests with the voters of Georgia.
There is one thing that is certain – the 2020 tax rates; and one thing that is near certain – tax rates in 2021 will not go down. Thus before the end of 2020, it may be prudent to accelerate income to incur the tax at the current known rates rather than take a chance of higher rates come next year.
The overarching concept with the Biden tax plan is to increase taxes on individuals with incomes exceeding $400,0000. The key elements of the plan as it affects higher income individuals are:
- The top tax bracket will increase from 37% to 39.6%. Presently the top tax bracket applies to single and head of household filers with income at $518,400; married filing joint of $622,050; and married filing separately at $311,025.
- Phase out of the Qualified Business Income Adjustment (IRC 199A) deduction for those with income over $400,000. Under present law, those with self-employment and flow-through business income are entitled to a deduction of up to 20% of net business profits, subject to certain phaseouts. The mechanics of the proposed new phaseout of this deduction has not been defined, nor how it interacts with existing phase-out provisions.
- Social Security payroll tax increase of 12.4%, evenly split between the employer and employee, based on income over $400,000. Presently, the Social Security tax of 12.4% is applied to the first $137,700 of earned income (wages, self-employment income, most types of partnership pass-thru income). Under Biden’s proposed tax plan, earned income from $137,700 to $400,000 would not be subject to this tax, creating a ‘doughnut-hole’, and over $400,000 the Social Security tax will resume.
- The tax benefit of itemized deductions will be capped at 28%, for income level over $400,000. Under present law, itemized deductions reduce tax starting at the individual’s top marginal bracket. As an example, an individual in the 39.6% tax bracket with $100,000 of itemized deductions will receive a $28,000 tax benefit from those deductions, as opposed to a $39,600 benefit without such a cap.
- Long-term capital gains taxed at the individual’s ordinary tax rate for income over $1 million. Thus, for top bracket individuals, the long-term capital gains tax presently at 20% will increase to 39.6%. On top of this, the Affordable Care Act surtax of 3.8% will remain in effect. The mechanics of this computation and how the $1 million income threshold is determined have not been disclosed.
- Electric vehicle manufacturer cap removed – thus the full $7,500 credit is allowed on the purchase of an electric vehicle regardless of how many cars the manufacturer produces. However, the credit will be limited to those with income under $250,000.
- Renters credit – Holding rent and utility payments at 30% of monthly income. No current federal tax law on this topic.
- Senior taxpayers – Increased tax benefits for long-term care insurance with their retirement savings. Creation of a tax credit of $5,000 for ‘informal’ caregivers-family members or loved ones, who provide the care; caregivers would also be able to make ‘catch-up’ contributions to retirement accounts. Current tax law allows long-term care insurance, and all other non-reimbursed medical and health insurance amounts to be deducted when the total is greater than 7.5% of the taxpayer’s AGI.
- 1031 (like-kind) exchanges will be eliminated. The tax reform act of 2018 had narrowed the use of 1031 exchanges to just real estate. The Biden proposal will do away with 1031 exchanges all together. Under current law, the recognition of the gain on the sale of real estate used for investment or income producing activities could be deferred if another property was identified within 45 days of sale and settled within 180 days of sale. This year, if not the next, may be the ideal time tax-wise to embark on any real estate sales for which a 1031 exchange is contemplated.
- Elimination of stepped-up basis on inherited assets. Current tax law allows stepped-up basis at time of death, resulting in beneficiaries receiving an appreciated asset that has escaped capital gains tax. In contrast, gifts never received such a step-up, with the recipient getting carryover basis. The elimination puts gifts and bequests on equal footing and makes estate planning all the more important. The estate tax itself will still be imposed, so moving potentially highly appreciating assets out of the eventual estate and into a trust should be considered.
As Benjamin Franklin famously said, “…in this world, nothing is certain except death and taxes.” Though we do not know how Biden’s proposal will ultimately turn out, we do know that taxes are not going away. Through the end of 2020, we have certainty with our tax laws, and planning should be done to take advantage of today’s tax rates, which we may fondly look back on as being among the lowest tax years in our history. To discuss your particular situation please contact your Aronson tax advisor at 301.231.6200.