By Michael Fischer, CFP
The likelihood of enacting substantial portions of President Joe Biden’s tax plan increased with the January run-off wins of two Democrat Senate seat wins in Georgia. Many of the proposals floated during the presidential election season would increase various taxes for high-income individuals and corporations. Below are some of the most likely changes that will affect your clients and that you should be mindful of when financial planning.
The current Federal Unified Gift & Estate Tax Exemption is set at $11.7 million for 2021, but this benchmark is scheduled to drop on Dec. 31, 2025. The exemption will revert to the 2017 level, which was about $5.5 million per individual, increasing annually for inflation. Biden’s proposal would reduce the exemption to the 2009 level, which was $3.5 million per individual. A lower federal exemption coupled with Pennsylvania’s existing inheritance tax may mean more estate tax returns for your practice in the years ahead.
Marginal Tax Rate and Social Security Increases
Marginal rates are likely to increase both for individuals and corporations. On the corporate side, the 21% flat corporate rate is expected to increase to 28%. There has also been discussion about a 15% tax floor on corporations with $100 million a year in net annual income (dubbed the “Amazon Rule”). On the individual side, the 37% rate is likely to increase to 39.6% again, and the income threshold at which that bracket will apply may be reduced to $400,000 for both individual and married filers. This will significantly erode the existing 32% marginal bracket.
The $400,000 threshold will also be significant for Social Security payroll taxes. For Social Security tax purposes, wages are currently taxed until reaching the cap of $142,800. Biden has proposed keeping the current cap but extending Social Security withholding on wages in excess of $400,000. For high earners, especially the self-employed, that 12.4% will be a significant increase in tax liability.
Capital Gains and Step Up in Basis
Biden has also presented proposals that target passive income generation in an attempt to narrow the gap between the 37% income tax rate and the preferential 20% capital gains tax. For individuals with income in excess of $1 million, gains will be taxed at ordinary income tax rates. This proposal will have far-reaching consequences on the sale of businesses and investment property, and may affect filers with one-time recognition events. Regarding investment property, not only may capital gains be taxed at a higher rate, but there is a proposal to eliminate the popular Section 1031 exchange, which allows a taxpayer to postpone the recognition of gains upon sale by replacing it with a new investment property.
In addition to the increased capital gains tax, assets may also lose their step up in basis upon death. It is unclear whether this would result in carryover basis (similar to Section 1015 on property received via gift or transfer) or whether death would be treated as a recognition event, requiring the gain to be reported on Form 1041.
Credits, Deductions, and Limitations
Among Biden’s proposals, the Child and Dependent Care Tax Credit would increase from $3,000 to $6,000, the Earned Income Tax Credit would be expanded, and the Child Tax Credit would become fully refundable. He would also reinstate the First-Time Homebuyers’ Tax Credit.
On high-income earners, Biden may reinstate the Pease limitation on itemized deductions and may phase out Section 199A (qualified business income) deductions at $400,000 for all pass-through entities, regardless of business type.
While not officially announced, there has been speculation that the $10,000 limitation on state and local tax deductions may be renegotiated, entitling those with higher property taxes to a full deduction, though potentially subject to alternative minimum tax (AMT).
Timing and Implementation
Because the first several months of the Biden administration has been focused on the coronavirus pandemic and providing a COVID-19 relief package, the lengthy negotiation that will accompany new tax proposals will not likely occur until the second half of 2021. Be aware that any tax reforms passed in the later part of the year likely would be effective January 2022; however, there is a chance they could be retroactive to January 2021. This possibility may hinder tax and estate practitioners’ ability to effectively develop plans on behalf of their clients. For clients who were hesitant in 2020 to accelerate income, recognize capital gains, or take advantage of the large estate tax exemption, there may be some ability for proactive tax planning now.
Michael Fischer, CFP, is a director, wealth adviser, for Round Table Wealth Management in Westfield, N.J. He can be reached at firstname.lastname@example.org.
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