With former Vice President Joe Biden now considered to be the President-Elect, there are rumors of potential tax and other legislative changes that could be implemented in the near future. Most of Biden’s proposed changes have the potential to greatly affect restaurants, hotels, distributors, and other retail business owners. Below is a summary of the potential changes that could be put in place.
Top Tax Rate on Ordinary Income
Under current law, the highest tax rate on ordinary income such as wages and business income is taxed at 37%. In 2020, the 37% tax rate comes into play when taxable income exceeds $518,400 for a single taxpayer and $622,050 for a married couple.
If Biden’s plan gets implemented, the highest tax rate of 37% becomes 39.6%.
Phaseout of the 20% Qualified Business Income (QBI) Deduction
When the Tax Cuts and Jobs Act (TCJA) was implemented in 2017, the TCJA allowed many business owners that were an S-Corporation, partnership, or other self-employed individuals to claim a deduction equal to 20% of the qualified income earned from their business operations. Business owners in the hospitality industry benefited greatly from the QBI deduction as it reduced the effective top tax rate on their business income from 37% to 29.6%.
Biden’s plan would phase-out the QBI deduction for taxpayers with taxable income in excess of $400,000. Effectively this would eliminate the QBI deduction for many hospitality owners and possibly increase their effective tax rate on their business income from 29.6% to 39.6%.
Increase in Minimum Wages
Currently, the federal minimum wage is $7.25 per hour but many states implemented higher hourly wages.
Biden is proposing an increase to the federal minimum wage from $7.25 per hour to $15 per hour. The increase in the minimum wage could result in additional labor costs for restaurants, hotels, distributors, and retail owners that are located in states that aren’t already trying to phase-in a minimum hourly wage of $15.
Elimination of Tipped Minimum Wages
Under current law, full-service restaurants in 43 states are allowed to count tips that their servers earn towards their hourly minimum wage. As a result, this leaves the restaurant operator with a tipped minimum wage that they are required to pay for but it’s significantly lower than the regular minimum wage. Also, restaurant operators are allowed to claim a federal FICA tip credit on their tax return equal to their employer share of the payroll taxes that are paid on tipped wages not used to meet the federal hourly wage rate of $5.15 for this specific credit.
Biden’s plan is to eliminate the tipped minimum wage altogether. This would result in the restaurant operator being liable for the entire cost of the hourly wages. The extra financial burden to the restaurant operator could impact their restaurant’s tipping policy moving forward such as having customers go from leaving discretionary tips to now paying service charges or automatic gratuities. Service charges or automatic gratuities would belong to the employer and could be used to fund the hourly minimum wages but would also be ineligible for the federal FICA tip credit.
Increase in Payroll Taxes
In 2020, the first $137,700 of wages or self-employed income are subject to a 12.4% Social Security tax. The Social Security tax gets split by the employer and employee on wage earnings while the self-employed earner is liable for the full 12.4% Social Security tax. All wages and self-employed earnings are subject to a 2.9% Medicare tax; the 2.9% Medicare tax is also split between the employer and employee on wage earnings. Those who earn wages and self-employed income above $250,000 (if married, $200,000 if single) are also subject to an additional 0.9% payroll tax.
Biden’s proposed plan wouldn’t change anything with the Medicare tax but would raise Social Security tax on WAGES ONLY above $400,000. This would create a donut hole where wages earners pay Social Security taxes on all their wages except on income earned between $137,700 and $400,000.
Top Tax Rate on Capital Gains
Long-term capital gains from the sale of assets held more than one year (e.g. fixed assets, goodwill from the sale of a business) are generally taxed at 15% for most people but get assessed the highest rate of 20% when taxable income exceeds $441,450 for a single taxpayer and $496,600 for a married couple.
Under Biden’s plan, the top rate on long-term capital gains would increase from 20% to 39.6% for taxpayers earning more than $1 million. This could significantly change the tax liability for hospitality owners that sell their business or fixed assets from their business for significant capital gains
Phaseout and Reduced Benefit of Itemized Deductions
Current law allows taxpayers to personally deduct the greater of the standard deduction ($12,400 for single taxpayers, $24,800 for married taxpayers) or the sum of their itemized deductions such as mortgage interest, state and property taxes (capped at $10,000), medical expenses and charitable donations.
Under Biden’s proposal, there would be two changes to itemized deductions. First, anyone earning over $400,000 would have their itemized deductions reduced by 3% for every dollar their income exceeds $400,000. Second, Biden would cap the tax benefit of itemized deductions at a tax rate of 28% when income exceeds $400,000.
Top Rate on Corporate Tax
Restaurants, hotels, distributors, and retail businesses that are structured as a C-Corporation currently pay a corporate tax rate of 21% directly at the entity level.
Under Biden’s plan, the corporate tax rate would increase from 21% to 28%.
Estate Tax Revisions
Currently, if someone were to pass away, the value of the assets in their estate that are in excess of $11.58 million get taxed at a rate of 40%. Also, the descendant’s assets transfer to their heirs at a “stepped-up” basis equal to their fair market value on the date of the death without a tax on the asset appreciation.
Biden’s proposed plan would raise the estate tax rate to 45% and drop the exemption from $11.58 million to $3.5 million. Also, any appreciation in your assets would be taxable income to your estate upon your demise. These changes if implemented could be a major game-changer for taxpayers in their estate planning especially hospitality operators with businesses that have a high fair market value or have accumulated a large amount of built-in appreciation over time.
It is still to be determined if and when which parts of Biden’s proposed plan will be implemented. However, it is critical to start thinking about these potential tax and labor law changes in how it could greatly impact your restaurant, hotel, distribution or retail business along with your individual tax and wealth planning.
Our tax specialists are also available for consultation on this for restaurants, hotels, and distributors. Please contact Aaron Boker or one of our hospitality tax advisors at 301.231.6200 for more information.