With the election behind us, and tax season ahead of us, tax planning is at the forefront of the minds of many. Although President Elect Joe Biden has shared his proposed tax plan, much is still up in the air as we await the January runoff elections to determine control of the US Senate.
In the meantime, let’s take a look at Biden’s proposed plan and its impacts.
Proposed Tax Increases
For corporations, Biden has proposed to:
- Increase the tax rate from 21% to 28%
- Impose a new minimum tax
- Increase taxes on foreign income
- Increase certain capital gain rates from 20% to 39.6%
For individuals, Biden has proposed to:
- Increase the top tax rate from 37% to 39.6%
- Create new limits on deductions
- Impose the 12.4% Social Security payroll tax on wages above $400,000
Proposed Tax Cuts
Biden’s proposed plan would:
- Temporarily expand the child tax credit from $2,000 to $3,000, and add another $600 for children under age 6. This credit would also become fully refundable, so the full amount could go to households that don’t owe any income taxes.
- Provide targeted tax incentives for caregivers, child-care expenses, and first-time homebuyers.
- Repeal the $10,000 cap on the state and local tax deduction, providing a tax cut for high-income households, especially in high-tax states such as New York and California.
Proposed Changes to Capital Gains
Biden has also proposed changes to capital gains tax. Under current legislation, assets that pass directly to heirs benefit from a tax planning tactic called a “step-up in basis”. This means that an individual may hold onto an asset for many years as it appreciates in value, then pass it to an heir at their death. The basis (the original investment in the asset) rises to the market value as of the date of death, and the heir inherits this “stepped-up basis”. Additionally, the heir benefit from a reduced (or no) capital gains tax if the heir chooses to sell the holdings they have inherited.
Under Biden’s proposed plan, tax would be levied on an asset’s unrealized appreciation at the time of death, doing away with the step-up in basis, and requiring the estate to pay taxes on the gains as if they are sold. His proposal would also increase capital gains taxes for certain taxpayers from 20% to 39.6%.
Additionally, Biden’s proposed plan would also reduce the federal estate tax exemption—the amount you may give away during your lifetime and own at your death without subjecting it to a 40% estate tax. Under current law, the federal estate tax exemption is $11,580,000, with a planned reduction to $6,000,000 as of December 31, 2025. Under Biden’s proposed plan, the federal estate tax exemption would halve the planned reduction amount, while increasing the estate tax rate from 40% to 45%. Typically, tax laws take effect in the calendar year after they are passed, so it’s possible that new rules could be enacted in 2022.
Impacts & Tax Planning
Taxpayers can make informed decisions by taking these changes into consideration during year-end tax planning, and when making tax and financial decisions as we move into the new year.
Below are some key considerations:
- When rates are expected to increase, accelerate income and defer deductions to future higher income tax years
- Harvest capital gains while these gains enjoy lower, more favorable rates
- Consider gifting assets before the possibility of a reduction of the estate tax exemption
The strategy behind year-end tax planning involves knowing which direction future tax rates will go. Year-end planning decisions typically consider the tax consequences of both the current year and the next year. If marginal tax rates are expected to remain unchanged or to drop, taxpayers consider ways to defer income to the next year and accelerate deductions into the current year. Conversely, if marginal tax rates are expected to increase in 2021, taxpayers should consider strategies to accelerate income into 2020 and defer deductions to 2021.
If you have questions about year-end tax planning or the impacts of any potential tax changes, leave a comment below, or feel free to contact me directly, I’m happy to help!