Possible Tax Changes That May Come With The Biden Presidency

A major part of President-elect Biden’s proposed changes to taxation is his pledge to not increase taxes on those making less than $400,000. The various proposed changes are designed to increase taxes only for those with earnings above $400,000, and in fact appear as though they could lower taxes for many individuals, couples, and families who make less than $400,000 because of new and increased tax credits.

Below are some highlights from the proposed and potential changes. It’s important to note that these are proposed and potential changes only. No bills or laws have been passed or signed to put these changes into effect. These could change or be eliminated entirely, and additional changes could be made as well.

Tax Brackets

The 39.6% tax bracket may be reinstated. Though this is already expected to occur anyway in 2026, the change may be accelerated to occur for the 2021 tax year. It is unknown at what income level the 39.6% tax bracket will take affect. Previously, it was $418,000 for single filers and $470,000 for joint filers, but it’s possible it will be moved down to $400,000. It may be that other tax brackets will change as well.

What you can do about it: If you are a high income earner, you could accelerate income to 2020 to pay taxes at the current lower income tax bracket. It could also be a good time for doing a Roth conversion. Another strategy is to defer expenses until 2021 to potentially use deductions to lower the AGI to a lower tax bracket.

Itemized Deductions

Itemized deductions may be capped at 28% of taxable income. This would have no affect on the 24% and below tax brackets. It would limit higher income tax brackets above 28%. It is clear that the $400,000 and higher income earners are being targeted here.

What you can do about it: If you would normally have itemized deductions totaling more than 28% of your taxable income you can increase your deductions this year by making certain expenses this year instead of next year, including charitable donations. For charitable contributions, you can consider Donor Advised Funds or Community Foundations for tax timing. Previously, the aim would be to accelerate deductions in a given tax year, but with this potential change the aim will become to time deductions to not go over 28% of taxable income for itemized deductions in any given tax year.

Social Security Wages & Taxes

For 2020, only income up to $137,700 is subject to Social Security tax. It’s possible that wages over $400,000 could be subject to the 6.2% Social Security withholding. If you’re self-employed or an employee of your own company, this effectively would change the Social Security tax to 12.4% (employee share plus the employer’s share).

What you can do about it: If you are a high income earner, you could accelerate income to 2020 to pay Social Security taxes at the current Social Security tax rates.

Retirement Plans

The tax deductions for contributions to IRAs, 401(k)s, 403(b)s, and other pre-tax retirement investment accounts may be eliminated. The deductions would be replaced with a flat percentage of the contribution. The Tax Policy Center estimates that it could be a 26% credit. In that scenario, tax payers in tax brackets below 26% would benefit because the credit is greater than their tax bracket. For example, if the income was $100,000 prior to the deduction, with a $6,000 IRA contribution the taxable income would be $94,000. At the 22% income tax bracket that is $20,680 in taxes versus $22,000, for a savings of $1,320 in taxes. Under the potential change, the tax savings would be $1,560 (26% of $6,000). Tax payments in tax brackets above 26% would actually pay more in taxes. This change is designed to offer a greater benefit to lower income earners who save for their retirement, and a smaller benefit to higher income earners who may not need as much assistance or motivation to save for their retirement.

What you can do about it: If you’re in a tax bracket below 26% and don’t normally maximize the contribution you could delay the contribution (or part of the contribution) until January and make it for the 2021 tax year. It is recommended to maximize contributions to tax advantaged accounts like IRAs though. Another question is if there will be a Roth loophole created by this new tax policy where you could contribute to an IRA and receive a 26% credit, but then turn around and do a Roth conversion and pay only the lower ordinary income tax rate (say, 22% or 12%) on the conversion, thereby benefiting from a credit from actually contributing to a Roth IRA in the end. If you’re in a tax bracket above 26% the only thing you really can do is maximize your contribution for this year to get the full deduction, if eligible. Going forward, higher income earners may want to consider contributing to Roth-style accounts instead.

Capital Gains & Qualified Dividends

Taxable capital gains and qualified dividend income over $1,000,000 would be taxed at ordinary income tax rates instead of the lower 15% or 20%. There may also be a 3.8% surtax on net investment income.

1031 exchanges would not be available for individuals with income over $400,000.

What you can do about it: Establish a capital gains budget to prevent capital gain income from exceeding $1 million in any given year. It may make sense to invest in tax-exempt bonds, low dividend paying stocks and mutual funds, variable annuities that have tax deferral, and utilize installment sales. It’s always a good idea to incorporate tax gain and tax loss harvesting into investment and tax planning strategies to mitigate potential tax liabilities, and that could become even more important under these potential tax changes. If there are existing capital gains losses that could benefit you with tax loss harvesting, it may be a good idea to utilize that strategy now for the 2020 tax year.

Tax Credits

The child tax credit may increase from $2,000 per child under 17 to $3,600 per child under 6 and $3,000 per child under 17.

The child and dependent care credit may increase from $3,000 for one child ($6,000 for two or more children) to a refundable credit of $8,000 for one child ($16,000 for two or more children).

A first-time homebuyer credit could be re-introduced as a refundable and advanceable credit up to $15,000. When this credit existed in previous years it was capped at 10% of the purchase price of a home, you’d only get the maximum credit with a purchase price of $150,000 or more. It is unclear how exactly this credit will work under the new administration.

A new caregiver credit could provide up to $5,000 for informal long-term caregivers.

What you can do about it: If you’re thinking of buying a home, you could wait to see if these proposals become reality and possible benefit from the $15,000 first-time homebuyer tax credit.

Student Loans

The new administration may implement a student loan forgiveness program. The details of how this would work or who would be eligible is not clear or known, but there’s been a lot of talk about this being done.

What you can do about it: Slow down the payoff of your student loans.

Estate Planning

The step-up in basis for inherited assets may be eliminated.

The applicable exclusion amount could be cut in half from $11.58 million to $5.79 million, which is where it used to be before the Tax Cuts and Jobs Act. It’s even possible it could be cut to $3.5 million.

What you can do about it: Regarding the step-up in basis change, there isn’t a whole lot that can be done right now, especially since it’s unknown how the step-up basis provision changes will work. It’s unknown if carry-over basis will apply or if the inheritance will be deemed a sale at death and subject to estate tax. For the applicable exclusion changes, you can gift in 2020 to take advantage of the current higher applicable exclusion amount. For future years, look into estate freeze techniques, possible SLATs, fractional gifting, Family Limited Partnerships, and some other techniques. The issues with the estate planning changes are that it’s near the end of 2020 and it’s unlikely an estate attorney would be able to complete anything before the end of the year. Be careful of gifting in 2021 prior to knowing what any of the new tax laws will be as you could be blindsided by retroactive application of new tax laws and pay gift tax when you weren’t expecting to.

Business Taxation

The QBI deduction may be eliminated for anyone with business income over $400,000.

C Corporation tax rates may increase from 21% back to the previous 28%.

For larger corporations with book income greater than $100 million, a minimum tax of 15% will be assessed on the book income. This is designed to prevent large corporations like Amazon from not paying any tax.

What you can do about it: If your business has annual income greater than $100,000 take advantage of QBI deductions now while you’re still able to. C Corporations can delay deductions into 2021 to help reduce income subject to the higher tax rate.

Impact on Specific Investment Sectors

There could be incentives for investing in green energy, or a reduction in incentives (tax loss harvesting for example) for investments that are in oil, gas, and coal.

What you can do about it: Invest more in green energy, and less in oil, gas, and coal. Look at SRI and ESG investments. See the previous article on SRI and ESG to get an idea of the advantages to SRI and ESG investing.

There Will Be More to Come

I’ll post more articles as more details about possible tax law and tax policy changes become known. If you’d like to stay on top of this information and other topics, you can subscribe to the Escient Financial Insights newsletter below. And as always, if you need assistance with anything feel free to...