A few years ago, in the Tax Cuts and Jobs Act of 2017, President Trump’s revised tax plan was one of the biggest changes to the U.S. tax code in history. Even though many of the changes in TCJA are scheduled to sunset in 2026, the outcome of this week’s election will have a major impact on the future of the tax code. If President Trump wins reelection, he will almost certainly attempt to make permanent many of the TCJA changes, whereas if former Vice President Biden wins, he’s already proposed the changes he’d like to see.
This piece focuses on those changes we’d see if Biden does get elected, specifically the changes at the individual and household level.
If you make more than $400k, you'll pay more taxes
Apparently, $400,000 is the dividing line. With income above this amount, you’ll be impacted by the changes below. Notably, it isn’t clear from Biden’s proposal whether this $400,000 threshold applies to single filers, married couples, or both.
- Increase the top marginal rate back to 39.6%. While this is only a 2.6% increase above the current top rate of 37%, more taxpayers will find themselves in this tax bracket since the $400,000 income threshold is lower than the current top rate threshold for both single and married filers. See the graphic below from Michael Kitces for the comparison of tax rates.
- Impose the 12.4% social security payroll tax on wages above $400,000. Currently, no wages above $137,700 are impacted by this tax. Biden’s plan would reintroduce this tax on wages above $400k, creating a donut hole where wages between $137,700 - $400,000 avoid the tax but wages below and above that range get hit with the tax.
- Eliminate the 20% qualified business income deduction. Currently, the QBI deduction allows owners of pass-through business to deduct 20% of their business income, meaning they’re effectively only taxed on 80% of their business income. Under the Biden plan, the 20% QBI deduction would be eliminated for taxpayers earning above $400,000.
- The value of itemized deductions capped at 28%. Currently, the value of deductions is equal to your marginal rate. The Biden plan would cap that value at 28%, meaning taxpayers in the 32%, 35% and the new 39.5% brackets would be impacted, but those in the lower brackets would not.
Example. Agnes and Ben both make $15,000 in charitable contributions. Agnes’s marginal rate is 22%, so she “saves” $3,300 in taxes. Ben’s marginal rate is 35% so he “saves” $5,250 in taxes with his charitable gift. Under the new plan, Agnes’s tax savings would be unaffected, whereas Ben would only save $4,200 in taxes.
- Replace deductions for contributions to pre-tax retirement accounts with a flat 26% credit. Like itemized deductions above, in the current system, contributions to your 401(k), 403(b), or IRA are deductions against your income, so their value is equal to your marginal rate. The Biden plan would replace those deductions with a flat 26% credit for all taxpayers. The result is that contributions to pre-tax accounts become more valuable to taxpayers below the 26% marginal rate, and less valuable to those above it.
Example. Agnes and Ben both contribute $10,000 to their 401(k). Agnes, whose marginal rate is 22%, “saves” $2,200 in taxes with that contribution. Ben, whose marginal rate is 35%, “saves” $3,500 in taxes with that same $10k contribution. Under the new plan, both Agnes and Ben would “save” $2,600—an increase for Agnes and a decrease for Ben.
- Eliminate 1031 exchanges. Currently, taxpayers can “exchange” tangible property held for investment with like-kind property and avoid triggering a tax bill on the sale of the property. Under the Biden plan, this maneuver—called a 1031 Exchange—would be eliminated for taxpayers with income greater than $400,000.
Other changes that will mean more taxes
While the above changes specifically impact taxpayers earning over $400,000, Biden’s proposal does include some other changes which aren’t tied to that magic number.
- Eliminate the step-up in basis rule at death. Currently, beneficiaries who inherit assets receive those assets with a cost-basis equal to the fair market value of the asset at the time of the original owner’s death. The basis of the asset is “stepped up” to its current value. This means that if they promptly sell that asset, there will be no “gain” on which they will owe taxes. The Biden plan eliminates the step-up in basis rule, meaning that heirs who sell appreciated assets that they’ve inherited will have to pay taxes on the capital gains of those assets.
Example. Clarence’s father’s house is worth $500,000. He bought the house 30 years ago for $100,000, so his cost basis in the house is $100,000. If he were to sell it, he would have a capital gain of $400,000. Clarence’s father passes away and leaves Clarence his house. Clarence inherits the house with a “stepped up” cost basis of $500,000—the fair market value of the house when his father passed away. If he sells the house, he will have no capital gain. Under the new plan, Clarence would inherit the house with his father’s cost basis of $100,000. Now, if he sells the house, he will have a capital gain of $400,000.
- Return estate and gift tax exclusion amounts to the pre-TCJA levels. Currently, the estate of a taxpayer pays no estate or gift tax on the first $11.58 million of their estate, an amount that was doubled as part of the Tax Cuts and Jobs Act. Under the Biden plan, this exclusion amount would be reduced back to its previous level of $5.79 million.
- Long-term capital gains taxed at ordinary income rates for those earning over $1MM. Currently, long-term capital gains are taxed at a maximum rate of 20%, plus a 3.8% surtax. Under Biden’s plan, for taxpayers whose income is over $1MM, any long-term capital gains would be taxed at ordinary income rates—which would be 39.6% at that income level—plus the 3.8% surtax.
Some good news - new and enhanced tax credits for families
Not all the changes proposed by Biden’s plan are tax increases. For many families with children, or people with aspirations to buy their first home, they may find their tax bill goes down under the new plan.
*Quick reminder about tax credits vs. deductions. Dollar for dollar, credits are more valuable than deductions. A $2,000 deduction reduces your income at which you’re taxed by $2,000. Even for someone in the 35% tax bracket, that’s a $700 tax savings. A tax credit reduces your tax bill directly. So a $2,000 tax credit is a $2,000 tax savings.
**A refundable tax credit is one that you can receive even if it lowers your tax bill to be less than $0. So, if you have a tax bill of $2,000 and you receive a refundable credit of $3,000, not only would it wipe out your $2,000 of taxes owed, you would also be entitled to a refund of $1,000.
- Expanded Child Tax Credit. The Child Tax Credit grants a $2,000 credit for each child under age 17. The Biden plan would increase the CTC from $2,000 to $3,000, with an extra $600 bonus for children under 6. It would also change the credit from being partially refundable to fully refundable.
- Expanded Child and Dependent Care Credit. The Child and Dependent Care Credit grants a credit worth up to 35% of childcare expenses up to $3,000 for one child and up to $6,000 for two or more children. The Biden plan would increase this credit to $8,000 for one child, and up to $16,000 for two more children. It would also make the credit refundable.
- New First-Time Homebuyer Credit. This new credit would be fully refundable and advanceable up to $15,000 to assist taxpayers making a first-time home purchase. It’s likely that the credit would be capped at a percentage of the purchase price.
- New Caregiver Credit. This new credit would grant up to $5,000 for taxpayers that provide informal care to those in need of long-term assistance.
Even if Biden wins the election, it isn’t yet clear that there are any sure-thing planning moves to make before the end of the year. However, there are some options to keep an eye on.
For example, some in high tax brackets should consider pulling deductions forward while they still have maximum value. Those in the highest tax bracket should consider pulling income forward before the top rate increases. Those with appreciated assets and one foot in the grave may think about kicking the bucket early so that their heirs can inherit those assets with a stepped-up basis (KIDDING!). Hopefully the time between the election and the end of the year will provide more clarity on what moves to make.
And if Biden loses the election, well, then you’ve just wasted about 7 minutes of your life that you’ll never get back. Cheers!