With Joe Biden confirmed as the president-elect, many people are starting to get nervous about their tax bills. After the sweeping changes made with the Tax Cuts and Jobs Act in 2017, the immediate assumption from many Americans is that things will go back to how they were when Biden was the VP and that they will see a tax increase. For some people, this would be the correct assumption. However, it’s important to understand what is included in the tax plan right now, and how it will impact you come tax time if legislation is ever passed. Here are some of the highlights.
Top Tax Bracket
Under Biden’s current plan, tax rates will remain unchanged for the majority of people. However, the highest income tax bracket is currently listed at 37%. Biden’s plan would increase this rate to 39.6%, which is the same top rate under the tax law prior to 2017. This top rate only applies individuals that have income over $520,000 and married couples that have income over $620,000, so many taxpayers are unaffected by this. However, if you are in this top bracket, be aware that you’ll see a 2.6% increase on any income above these thresholds.
Long-Term Capital Gains & Qualified Dividends
Under current laws, long-term capital gains and qualified dividends are given favorable tax treatment. This income is taxed at either 0%, 15%, or 20% (not including net investment income taxes, which could add another 3.8% for certain taxpayers). Under Biden’s plan, any taxpayer earning more than $1 million would instead pay up to 39.6% on this income. This essentially means that it will be taxed as ordinary income, removing its favorable treatment. Most of the people I know don’t have to worry about this one, but the people that do are understandably very worried about it.
Corporate Tax Rates
The Tax Cuts and Jobs Act in 2017 cut corporate tax rates significantly. It created a flat 21% tax rate for all C-Corporations, which was significantly lower than the prior maximum tax rate of 35%. Biden’s plan would likely increase this flat rate from 21% to 28%. This is still lower than prior tax rates, but does represent a significant increase for C-Corporations. It would not impact LLC’s or S-Corporations though, which is good for many small businesses.
Another important highlight of Biden’s tax plan involves the Qualified Business Income (QBI) Deduction. This is a 20% deduction available to pass-through businesses such as sole-proprietorships, partnerships, and S-corporations. Under Biden’s plan, this deduction would be eliminated for taxpayers with taxable income above $400,000. Under current law, this deduction became subject to additional limitations near this same threshold, but Biden’s plan would eliminate the deduction entirely for taxpayers with this level of income.
Payroll Tax Increase
In 2020, all wage-earners are subject to a 6.2% social security tax on wages up to $137,700. After this limit is reached, any additional wages are exempt from social security taxes. Under Biden’s plan, this would remain unchanged until the taxpayer reached $400,000 in wages. Once this happens, any wages in excess of $400,000 would be subject to social security taxes again. This is a pretty odd feature of his tax plan because it creates a significant gap between the two, meaning the tax would stop and start for high-earners. The reason for this is really for branding purposes, as his plan revolved around the idea that only individuals earning over $400,000 would see an increase.
Basis in Inherited Assets
Under current tax law, when you die and pass on assets to your heirs, they receive what is called a “step-up” in basis. Let’s say you purchased some stock for $100,000 about 40 years ago. When you die, it’s worth $300,000. Under current law, you do not pay income taxes on the unrealized gains of $200,000. Instead, your heirs receive the $300,000 worth of stock and treat it as if it was purchased for $300,000. This prevents the heirs from having to pay taxes on the unrealized gains if they decide they want to liquidate the stock and take the cash.
Biden’s plan would update this so that when you die, it is as if your assets have been sold, meaning you’ll pay income taxes on the unrealized gains on your final income tax return. I’m not sure if this one will get enough support to be included in any final legislation only because it is a major administrative headache. If you don’t agree, try to figure out how much your grandma paid for her house 50 years ago without asking your grandma. It can be difficult to tie these things down, which is a part of why the step-up in basis exists.
Most people are inclined to think that Biden’s tax plan will only include tax increases. However, for lower-income individuals, there would likely be many tax cuts included in the package. The child tax credit would increase from $2,000 per child to $3,600 per child. Dependent/daycare credits would increase from a maximum of $3,000 to a maximum of $8,000. It would also include a credit for first-time homebuyers as well as a renters credit.
Will it Pass?
Maybe. There is a runoff happening in January for 2 senate seats in Georgia. If democrats get both of these seats, the senate will be split 50-50. This means that any tie-breaker vote would belong to Kamala Harris, making it more likely they’ll be able to get something passed. However, even if democrats get these two senate seats, I wouldn’t expect the whole plan to pass as-is. There are many items that not all democrats will agree on. Since they would likely need every single democratic vote in the senate to get a bill passed, I would assume that some things may be left out to get everyone on board. Also, if republicans win even one of these seats, it will be very unlikely that any tax legislation will get passed in the next two years.
To sum up, I still don’t know what will happen and neither does anyone else. The super wealthy are correct in saying that their taxes will go up, and your middle-class neighbor complaining that his taxes are going to double is misinformed. As always, for any and all of your tax needs, feel free to contact me for a free consultation.