Presidential nominee Joe Biden’s campaign has proposed many major tax reforms as we near the November 2020 election. Much of this reform targets the legislation enacted by President Trump’s Tax Cuts and Jobs Act (TCJA) of 2017. While these are just proposals for the time being, they provide significant insight into the presidential nominee’s position on our tax system and the types of reforms his regime may consider if elected President. And of course, much depends not only on Biden winning his election bid, but also on who gains (or holds onto) control of the Senate. The following is a high-level summary of some of the proposed changes that would have significant effects on closely held businesses and owners – not just corporations and the wealthy.
- Top Marginal Rate – Increasing the marginal tax rate on top earners by increasing the tax on the highest ordinary income tax brackets from 37% to 39.6%. This would be an effective reversal of the TCJA reduction.
- Income & Payroll Tax – In addition to upping the top marginal rate, the proposal aims to reinstitute payroll tax on earned income above $400,000. Currently, both the employer and employee pay the combined 12.4% payroll tax on earned income up to $137,700. The change would mean that high-earning business owners who pay both the employer (6.2% and employee (6.2%)) tax would see their total rate jump from 37% to 52% – a monumental change for business owners. According to TaxFoundation.org, this change is estimated to be the second-largest tax revenue driver of Biden’s proposal resulting in approximately $820 million of revenue.
- Capital Gains – Currently, the highest long-term capital gains tax rate is 20% for earners in the $400s. Under the proposal, earners over the $1 million mark would be taxed at the ordinary income tax rate of 39.7% plus the Net Investment Income Tax (which remains unchanged) of 3.8%). This is a huge increase – roughly 23.5% for high earners. In addition to this, 1031 Exchanges – a common strategy for capital gains tax deferral – would be removed for income earners of $400k or more.
- Small Business Tax – The Biden team proposes removing existing tax deductions, including phasing out the qualified business income (QBI) deduction (Section 199A) for earners above $400,000. The small businesses below this level would remain eligible for the 20% QBI deduction.
- Corporate Tax – Under the TCJA, the corporate tax rate was cut from 35% to 21%, and the corporate Alternative Minimum Tax (AMT) was repealed. Under the proposed plan, the corporate tax rate would increase to 28% and an alternative to AMT in the form of a minimum 15% tax on certain, very large companies (think Amazon) would be instituted. According to TaxFoundation.org, this is the single largest cumulative effect on tax revenue for the 2021-2030 period when compared to the existing plan, which amounts to an estimated $1 billion of revenue.
In addition to these major changes, Biden’s proposal includes two key changes that affect the next generation. The first is the elimination of a step-up for cost basis on inherited property. It is important to note that eliminating the step-up in basis on inherited assets affects more than the top 1%. Currently, there is no tax on inheriting estates with appreciated assets such as real estate. The proposal outlines that heirs would inherit the decedent’s basis and pay gains on realization. If, for example, a person purchased a home for $400,000 that is worth $1.5 million at the time of their death, their heir would pay capital gains on anything over $1.5 million. This “step-up” in basis would be eliminated meaning if the heir sold the home for $1.6 million, they would pay capital gain tax on $1.2 million.
The second main change for estate and tax planning surrounds the unified gift and estate tax exemption. The proposal reverses the TCJA lifetime exclusion of $11.58 million per person back to the pre-TCJA amount of $5.49 million (to be adjusted for inflation). Depending on the outcome of the November election, individuals this would affect may want to consider using as much of their exemption as possible in 2020 to provide meaningful federal tax savings to their heirs. Should the exemption be cut in half, anything above this threshold would be taxed at 40%.
It is important to note that the Democratic candidate has proposed new and enhanced existing tax credits for individuals, families, and certain businesses. Proposals include expanding the Child and Dependent Care Tax Credit (CDCTC), providing a First Time Homebuyer Credit, and shifting the tax benefits of deferrals into traditional retirement accounts towards lower and middle-income earners. Overall, however, a model run by TaxFoundation.org finds that the plan as proposed would reduce GDP by 1.47% over the long term, lead to a 1.7% decline in after-tax income on average for all taxpayers, and lower after-tax income for all income levels by 2030. Whether you are in the highest or lowest income tax bracket it is important to consider how these proposals would affect both your family and the economy – and to be ready to adapt your financial plan to whatever tax regime will exist in the coming years
For additional information, please see: Garrett Watson, Huaqun Li, and Taylor LaJoie, “Details and Analysis of Democratic Presidential Nominee Joe Biden’s Tax Proposals,” Tax Foundation, September 2020, https://files.taxfoundation.org/20200928134201/Details-and-Analysis-of-Democratic-Presidential-Nominee-Joe-Bidens-Tax-Proposals-September-2020-Update.pdf