President Elect Joe Biden’s campaign platform includes proposed tax changes which could negatively impact high net worth taxpayers. With wins by the Democrats in the two Georgia Senate runoff elections, it is now more likely some of the proposals may pass.
Of course, even if passed, we don’t know whether the provisions would be effective from date of passage, retroactively to the beginning of the year or even prospectively to next year. A brief description of some of the significant proposed changes follows.
Change in Top Income Tax Bracket
The Biden tax plan would increase the top tax bracket for taxpayers earning more than $400k back to the 39.6% rate in effect before the Tax Cuts and Jobs Act (TCJA) reduced the bracket to 37% in 2018. It is unclear whether the $400k threshold would be the same for joint and single filers. The chart below assumes they are the same.
Change in Tax Rate on Long Term Capital Gains
Under current law, long term capital gains (gains on the sale of investment assets held for more than one year) are taxed at preferential rates with a maximum rate of 20%. The Biden tax plan would eliminate the preference and tax long term capital gains as ordinary income to the extent the taxpayer’s income exceeds $1 million. This is a dramatic difference, almost doubling the rate today and would be the highest effective tax rate since 1977.
Cap on Itemized Deductions
Another key element of the Biden tax plan is a prospective cap on itemized deductions at the 28% tax bracket. That would mean taxpayers in the 32% income tax brackets and higher would not fully benefit from their deductions because each dollar of allowable itemized deductions could not lower the federal income tax bill by more than 28 cents.
Limitation on Deduction for Retirement Plan Contributions
Currently, contributions to a traditional 401(k) plan are made with pretax dollars. These contributions reduce your taxable income and trim your tax liability. President elect Biden proposes “equalizing” the benefits of the deduction, which analysts say could result in a tax credit estimated at 26%. The change would essentially create a tax on contributions for taxpayers with effective tax rates above 26%. Such a change would make Roth accounts, wherein taxpayers contribute after-tax dollars and draw them down tax-free in retirement, more attractive to high income earners and less attractive to those in lower brackets.
Elimination of Capital Gains Step Up at Death
Currently, when a decedent passes away, assets in their estate typically receive a basis step-up to fair market value when inherited by a beneficiary. Instead of the beneficiary’s cost basis being the same as the decedent’s, it becomes the fair market value at the date of death. If the beneficiary sells the asset, they can do so with little to no capital gains tax. In Biden’s plan, the step-up would be eliminated and the beneficiary would either assume the decedent’s cost basis in the asset or the unrealized appreciation could be taxable at the decedent’s death. The step up was eliminated twice in recent history (1979 and 2010), but both times proved so unworkable (largely because of the inability to locate records of tax basis) that it was repealed. Nevertheless, advances in technology may make tracing the carryover basis more feasible and therefore, the repeal of the step-up more viable.
Reduction in Lifetime Estate & Gift Tax Exemption
Under the TCJA, the value of assets that can be passed free of estate and gift taxes was increased to an inflation adjusted exemption amount of $11.58 million for individuals and $23.16 million for couples. The higher exemption automatically sunsets back to the pre-TCJA level in 2025 unless further legislative action is taken. The Biden tax plan calls for reduction in the exemption amount to the 2009 amount of $3.5 million for individual taxpayers.
Increase in Top Estate & Gift Tax Rate
The Biden tax plan calls for an increase in the maximum estate and gift tax rate from 40% to the 45% rate in effect in 2009.
Elimination of 1031 Exchange
President elect Biden has proposed eliminating the tax preference for 1031 “like kind” exchanges for investors with incomes greater than $400k. Under current law, investors in real estate can exchange their property for “like kind” investments without recognizing gain. Instead, the new property takes a carry-over basis which defers taxation until the property is ultimately sold outside of a 1031 exchange.
Elimination of 20% Deduction for Pass-Through Business Owners with Income > $400k
The TCJA created a 20% deduction for pass through income (i.e., K-1 reporters). The deduction does not apply to taxpayers above certain income thresholds in specified service trades or businesses (SSTBs) – a list that includes accounting, law and financial services firms. Under Biden’s tax plan the deduction would be eliminated for all pass through entities.
What about the SALT Itemized Deduction Limitation?
Under the TCJA, deductions for state and local taxes (“the SALT deduction”) are capped at $10,000 (for both single taxpayers and married couples filing a joint return). The $10,000 cap includes both state and local income taxes, as well as property taxes. Taxpayers living in areas of the country with high SALT taxes such as California and New York, were disproportionately impacted. While the Biden tax plan does not address the SALT deduction limitation it is likely the limitation will be repealed, since the most impacted areas of the country are largely Democratic party-controlled,.
General Disclosures: Please consult your Tax Advisor for a complete discussion of your situation and specific tax consequences. The content contained in this article represents the opinions and viewpoints of Cardan Capital Partners only. It is meant for educational purposes and not meant for consumer decisions. All expressions are as of its publishing date and are subject to change. There is no assurance that any of the trends mentioned will continue in the future. Market performance cannot be predicted, so nothing in our commentaries is ever meant to provide any kind of trading advice or guarantee of future results. Certain information contained herein has been obtained from third party sources and, although believed to be reliable, has not been independently verified and its accuracy or completeness cannot be guaranteed. Any reproduction or distribution of this presentation, as a whole or in part, or the disclosure of the contents thereof, without the prior consent of Cardan Capital Partners, LLC, is prohibited.