Planning is a huge part of what we do here at iNNOVA so we think it’s important to understand what to expect (and begin to plan for) if there is a change in the White House after the upcoming election. Everyone should be familiar with President Trump’s stance on our tax code as he oversaw one of the largest tax overhauls in our history with the passing of the TCJA in 2017. The result is current tax laws that tend to favor lower tax rates, business-friendly incentives, and large deductions for individuals. If he wins the election, we expect our tax code to remain largely unchanged.
However former Vice President Biden’s plan would create a more progressive system and would result in lower tax rates to lower income individuals and higher tax rates to higher income individuals than what we have currently.
Today we are going to look at what we think are the top 5 changes that could occur under a President Biden Tax Plan
Tax brackets change for high income earners
One main change under Biden’s current plan would be a change in the top tax bracket from 37% to 39.6% which at first does not seem like a huge deal however the rate is not the only change. Biden’s plan also lowers the threshold to land in the top tax bracket as well. Currently the top tax rate is not hit until single filers have income more than $418,000 and joint filers require $470,000 in income before they hit that rate. Under a Biden plan the new top rate would be hit at $400,000.
Cap the value of Itemized deductions at 28%
This item would have no effect on taxpayers in the tax brackets below 28% so a lot of taxpayers would have nothing to worry about. However, people who find themselves in the higher tax brackets could see a substantial increase in the amount of taxes they pay. Let us look at an extreme example to illustrate; let us say a taxpayer is in the highest tax bracket of 39.6% and earns an extra $100,000 and then donates that income to a charity. In the new plan this person would receive a deduction of $28,000 (28% of $100,000) however their tax bill on the $100,000 of income would be $39,600 (39.6% of $100,000) leaving them with a tax bill of $11,600 even though they earned $100,000 and gave it all to the charity.
Flat credit (instead of a deduction) for retirement account contributions
Biden’s proposal includes the elimination of a tax deduction for retirement plan contributions and would replace it with a credit (the exact percentage has not been revealed yet). The most common percentage projected is 26% since it would be revenue neutral (according to the Tax Policy Center). This would have a similar effect to capping deductions at a specific tax rate. All taxpayers who are in lower brackets than the percentage chosen would receive a tax benefit greater than the tax burden had they not made the contribution. Conversely (like the cap on deductions) a high-income earner would end up paying taxes on their income and then only receiving a partial offset on the tax liability.
Increase long-term gains tax on high earners
Under Biden’s plan anyone who’s income exceeds $1,000,000 would pay ordinary tax rates on long-term capital gains as well as qualified dividends. This item is simple, if your taxable income is higher than $1,000,000 any income from long term gains or qualified dividends above that amount will be taxed at 39.6% instead of 20% for an almost doubling of the current tax rate. It is important to note that only the amount of long-term gains above $1,000,000 would be taxed at this higher rate. For example, if you had ordinary income of $500,000 and additionally $600,000 of long-term capital gains (perhaps from the sale of a business or property) than only the $100,000 above the $1,000,000 threshold would be taxed at the higher rate.
Elimination of Step-up in basis
Currently the Biden tax plan calls for the elimination of the step-up in cost basis on assets inherited at death. Today when the owner of an asset dies the cost basis to that asset is equal to the market value on the date of the decedent’s death. This can have massive tax benefits for the person who inherits assets. Again, let us use an example to illustrate. Say a person bought 1,000 shares of Google stock on 12/31/2004 for $96,000 and they have held them until their death on 9/30/2020. On the date of their death their 1,000 shares would be valued at $1,469,600 which implies an embedded capital gain of $1,373,600 ($1,469,000 – $96,000 = $1,373,600). This gain is totally eliminated with a step-up in basis when inherited, meaning the new owner of those shares could sell them and pay $0 in taxes! Without this step-up in basis at a minimum the tax liability would be 15% of the gain or $206,040!
There are many other proposed changes in the progressive tax plan including reducing the estate tax exclusion, increasing certain child care credits, changes in the ability to implement 1031 exchanges, the list goes on and on and we will certainly be keeping an eye on how things materialize. It is important to remember that even with a change in the President there is no guarantee that any or all the proposed changes will actually take effect so no decisive action should take place until it’s clearer what the final changes could be, if any.
As always if you have any questions about these potential changes and how they might affect your financial plan please do not hesitate to reach out to us as we are always here to help!
Your team at iNNOVA Wealth Partners
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