Will Joe Biden Raise YOUR Taxes?
During the campaign, Joe Biden promised that he would raise taxes for some people. Will you be one of them?
Now that the election is over, some Americans are worried that they're going to have to pay more in taxes in the near future. During the campaign, President-Elect Joe Biden wasn't shy about telling the American public that he wants to raise taxes on the wealthy. That's a big part of his overall tax plan. But what, exactly, does he mean by "wealthy"? Biden has repeatedly said he won't raise taxes on anyone making less than $400,000 per year. That appears to be a nice, clean, easy to understand dividing line between those who'll pay more taxes and those who won't. Unfortunately, though, it's not that simple.
Some Biden tax proposals could increase taxes on Americans who don't earn $400,000 in a year. For example, the $400,000 threshold generally applies to income taxes and certain payroll taxes. But Biden has called for changes that would raise other taxes, too. People making less than $400,000 per year could get caught up in those tax increases. Boosting business taxes could also have a trickle-down effect that indirectly raises taxes for workers. So, just because your annual salary is below $400,000 doesn't mean you'll automatically escape all Biden's proposed tax increases.
Also remember that the president can't raise or lower taxes on his or her own. Congress has to pass legislation to adjust taxes and then send the bill to the president for a signature. Since it looks like the Republicans will most likely control the U.S. Senate for at least the next two years, Biden is going to have a tough time getting his tax proposals enacted into law. He might also decide to wait before attempting to raise taxes. He'll need to focus on COVID-19 issues right off the bat, and raising taxes before the economy recovers is risky.
Having said all that, let's take a look at some of the people who should be the most concerned about tax increases once Biden takes office. Just remember that this isn't necessarily an all-inclusive list – other people could also face higher taxes in 2021 and beyond, too. The tax increases for other people might be relatively small, but you're not completely out of the woods if you're not on the list.
People Earning at Least $400,000
As we already mentioned, Biden says he won't raise taxes on Americans earning less than $400,000 per year. But, it seems, it's open season for anyone making more than that amount. In fact, Biden has pushed several tax proposals that would lighten the wallets of people earning $400,000 or more.
First, Biden wants to raise the top individual income tax rate from 37% to 39.6%. In other words, he wants to undo what President Trump's Tax Cuts and Jobs Act did back in 2017 (the TCJA temporarily lowered the top rate from 39.6% to 37% until 2026). For 2020, the following taxpayers will pay tax at the highest tax rate:
- Single filers with taxable income over $518,400;
- Joint filers with taxable income over $622,050;
- Married couples filing separate returns with taxable income over $311,025; and
- Head-of-household filers with taxable income over $518,400.
(For the complete 2020 tax brackets, see What Are the Income Tax Brackets for 2020?)
It isn't clear if Biden will also try to adjust the top-rate brackets so that they start at $400,000. If he does, that would result in a tax increase for single, joint, and head-of-household filers making between $400,000 and the current threshold amount. Currently, they're not paying income tax at the top rate. If the threshold is moved up to $400,000 for married couples filing separate returns, that would result in a tax increase for people earning between $311,025 and $400,000, because they would be pushed into the highest bracket even though they aren't there now.
Biden also wants to make wages above $400,000 subject to the 12.4% Social Security payroll tax (half paid by the employee; half paid by the employer). For 2020, wages above $137,700 aren't subject to the tax (the amount is adjusted annually for inflation). However, instead of just imposing the tax on all wages, Biden only wants to add wages above $400,000 to the levy. That would create a "hole" in the tax – wages between $137,700 and $400,000 would not be taxed. The bottom threshold amount ($137,700 for 2020) would gradually increase through inflation adjustments, so the hole would eventually be filled, but that would take a long time to happen.
Small business owners earning $400,000 or more might also see a tax hike during the Biden administration by losing a valuable deduction. The TCJA added a 20% deduction for "qualified business income" from pass-through entities (e.g., partnerships, S corporations, and limited liability companies). Biden supports phasing out the QBI deduction for small business owners making more than $400,000 for the year.
TAX TIP: If you're worried about higher taxes in 2021, consider moving some taxable income into 2020 if you expect to earn more than $400,000 next year. For instance, think about shifting money from a traditional IRA a Roth IRA in 2020. You'll pay tax on the rollover amount now, but it'll be taxed at 2020 rates instead of at whatever rate is imposed when you withdraw the funds in retirement. If you own a pass-through entity, see if you can shift QBI into 2020 to get the full 20% deduction. Also, see if your boss is willing to move some of your salary or bonus money into 2020 to drop your wages below the anticipated $400,000 Social Security tax threshold for 2021 – both you and your company could save money. Again, if the Republicans maintain control of the Senate, higher tax rates in 2021 will be difficult to push through Congress. But it isn't impossible, especially if Democrats are able to capture the Senate.
Wealthy investors would be affected by Biden's plan to do away with favorable tax rates on capital gains. Currently, gains from the sale of stocks, mutual funds, and other capital assets that you hold for at least one year are taxed at either a 0%, 15%, or 20% rate. Wealthier taxpayers – single filers with taxable income over $441,451, head-of-household filers with taxable income over $469,051, and joint filers with taxable income over $496,601 – end up paying the 20% rate.
However, if Biden gets his way, anyone making more than $1 million per year would have to pay tax on long-term capital gains at the top income tax rate for ordinary income. That's currently 37%, but don't forget that Biden also wants to kick that back up to 39.6%. So, millionaires could potentially see a 19.6% tax increase on capital gains.
And let's not forget about the 3.8% surtax on net investment income (e.g., taxable interest, dividends, gains, passive rents, annuities and royalties), which hits single taxpayers with a modified adjusted gross income over $200,000 and joint filers with a modified AGI over $250,000. Biden hasn't suggested doing away with or otherwise modifying this extra tax, which means investors earning $1 million or more could actually see their tax rate on capital gains soar to 43.4%. (Note that the 3.8% surtax would no longer apply if the U.S. Supreme Court strikes down Obamacare in its entirety.)
Biden's plan to reform the Opportunity Zone program could cost wealthy investors, too. Under the program, you can defer capital gains from the sale of business or personal property by investing the proceeds in qualified opportunity funds (QOF), which in turn invest in economically distressed communities. However, QOFs typically require investors to have a high net worth, a minimum annual income, and at least a six-figure investment. As a result, these investment vehicles, and the tax breaks that go with them, are mainly for the wealthy. Among other things, Biden wants to make sure the tax benefits are only available if there are also clear economic, social, and environmental benefits for people living in the distressed communities.
TAX TIP: It might be time for millionaires to sell some of the stock or other capital assets they've been holding for a year or more, especially if you were going to sell soon anyway. If you're worried about higher capital gains tax rates next year, realize gains in 2020 and take advantage of the favorable tax rates while you still can. Tax-loss harvesting (i.e., selling assets at a loss to offset capital gains) might also help reduce your tax burden.
One Biden proposal that hasn't received a lot of attention is capping the value of itemized deductions at 28%. Generally, the plan is to reduce the total amount of itemized deductions for anyone paying a marginal tax rate above 28% – that is, taxpayers in the current 32%, 35% and 37% tax brackets…or the proposed 39.6% bracket. For example, instead of itemized deductions for the wealthiest taxpayers being worth 39.6% (assuming that's the rate they'll pay under Biden's plan), that value would be capped at 28% and their itemized deductions would be reduced accordingly (similar to the itemized deduction limit that existed before the TCJA). In other words, instead of a wealthy person getting a 39.6% tax reduction for every dollar spent on, say, charitable gifts, he or she would only get a 28% tax reduction for every dollar donated to charity.
Note that the current 32% tax bracket applies to single taxpayers with taxable income as low as $163,301 and to joint filers with $326,601 of taxable income. As a result, limiting the value of itemized deductions to 28% could mean higher taxes for people earning less than $400,000. However, we could use some more clarity on this point. Unlike other income tax proposals, Biden hasn't specifically said this itemized deduction limit would only apply to people earning $400,000 or more (although the Washington Post reported that an unidentified Biden campaign adviser said the $400,000 threshold would apply to the cap). The cap might fall under the general "no tax on people earning less than $400,000" mantra, but we'd sure like to hear that from Biden himself.
There's also another limit on itemized deductions that Biden has talked about. He wants to phase-out itemized deductions for people earning more than $400,000 for the year. Actually, this is simply a reversal of the TCJA's repeal of the so-called "Pease limitation" (named after Congressman Don Pease (D-Ohio), who drafted the tax code provision establishing the limit.)
TAX TIP: Increase charitable donations in 2020 if you expect to be trapped by these potential itemize deduction limitations next year or beyond. Think about opening a donor-advised fund if you want to get your tax deduction now, but spread out donations to your favorite charities in the future. Also, before the year runs out, try to prepay deductible expenses, such as mortgage payments and state taxes due in January.
Estates Over $5 million (and Their Heirs)
Biden has also set his sights on lowering the federal estate tax exemption, which would subject more estates to the tax. In 2017, any estate worth less than $5.49 million was exempt from tax. Thanks to the TCJA, the exemption amount for 2020 is now up to $11.58 million (it will be $11.7 million in 2021). Biden wants to bring the exemption back down.
Although he hasn't said exactly how low he'd like it to go, we think he'll probably try to set the exemption amount at pre-TCJA levels – so around $5.5 million. (Even if Biden isn't successful, the TCJA exemption amount is only temporary and is currently scheduled to expire in 2026.) That means estates worth about $5.5 million to almost $12 million would suddenly be hit with an estate tax if Biden's plan is implemented. For those estates, it's a tax increase – going from 0% in taxes to a 40% estate tax.
While this seems like a tax increase that only impacts the superrich, people of modest means can also be affected by the change. The estate tax is paid by the estate, not by your heirs. But that means that one or more of the beneficiaries are inheriting less than they otherwise would if no tax (or less tax) had to be paid. So, in effect, this tax increase is really an indirect tax on the people who inherit your property. And those people certainly could earn less than $400,000 annually.
TAX TIP: Giving away cash or property while you're alive can help you reduce or even avoid estate taxes when you die. The general rule is that any gift is subject to the federal gift tax. However, there's an important exception to this rule — you can give up to $15,000 per person during the year without having to pay any tax. If you're married, your spouse can also give $15,000 to the same people, jacking the annual tax-free gift up to $30,000 per person. And you can do that year-after-year without paying any gift tax unless the total of all your non-exempt gifts exceeds the lifetime limit, which is the same as the estate tax exemption amount. Plus, as long as your gifts stay below the annual limits, whatever you give away won't be counted for estate tax purposes when you die. So, for example, if the current value of your estate is above the federal estate tax exemption amount ($11.58 million for 2020), giving away assets now could drop the value below the exclusion amount, which would mean no federal estate tax when you pass away.
Heirs Inheriting Capital Assets
There's another way your heirs could be screwed by one of Biden's tax proposals. He wants to eliminate the step-up in basis for inherited capital assets, which means more taxes on wealth passed to heirs.
Here's how the step-up in basis lowers taxes: Johnny's grandmother bought some stock years ago for $10,000. When she dies, Johnny inherits the stock – which is now worth $100,000. Johnny immediately sells the stock for $100,000. When you sell stock (or other capital assets), you pay tax on the gain – which is the amount you got when you sold the stock minus the "basis" (generally, the amount paid for the stock). In this case, Johnny's gain would be $90,000 ($100,000 - $10,000). However, when you inherit a capital asset, the basis is increased ("stepped up") to the fair market value of the asset on the date that the person who owned it died. So, in this case, Johnny's basis in the stock automatically jumps up from $10,000 to $100,000, which means he has zero gain because the selling price and the basis are identical ($100,000 - $100,000 = $0). No gain = no tax for Johnny.
If Biden is successful in eliminating the step-up in basis, Johnny is going to be paying tax on $90,000 of capital gain. Assuming Johnny isn't a millionaire (see above), at least he would still be able to take advantage of the favorable tax rates for capital gains since the gain from the sale of inherited assets is treated as long-term gain. But still, going from no tax to potentially paying a 15% or 20% tax is a tax increase for him. And, since Johnny's salary doesn't impact whether the stock basis is stepped-up or not, we can put this tax increase on the list of Biden proposals that could hit people earning less than $400,000 per year.
TAX TIP: For certain people, a life insurance retirement plan (LIRP) might be something worth looking into if the step-up in basis for inherited assets goes away (or even if it doesn't). As the name suggests, a LIRP is a cash value life insurance policy that can provide some of the same tax advantages as a Roth IRA, such as tax-deferred growth and tax-free income during your golden years. Since it's a life insurance policy, a LIRP provides death benefits for your beneficiaries, too – and life insurance proceeds received by a beneficiary following the death of an insured person are generally tax-free. So, if you can't pass tax-free capital assets to your children or grandchildren, listing them as a beneficiary on a LIRP might be a good alternative method of providing for them after you're gone.
Middle- and Lower-Income Americans
The Biden tax plan gets a little tricky when it comes to ordinary Americans. On the one hand, Biden has talked a lot about tax cuts for low- and middle-income people. For example, his overall tax plan includes proposals to increase the child tax credit, expand the child and dependent care credit, and exclude forgiven student loan debt from taxation. In addition, while he wants to repeal those portions of the TCJA that lowered taxes for the wealthy, he doesn't intend to do away with the TCJA provisions that help other Americans.
On the other hand, middle- and lower-income people could take an indirect hit from some of Biden's tax proposals. For example, we've already discussed how anyone could be negatively affected by a lower estate tax exemption or the elimination of the step-up in basis for inherited capital assets (although the overall impact of these tax increases will fall on wealthier Americans). Biden also wants to raise the corporate tax rate from 21% to 28%, impose a 15% minimum tax on large corporations, and take away certain corporate tax breaks. These business tax increases could create a trickle-down effect that indirectly increases taxes for most American families.
For instance, the American Enterprise Institution found that most of the new tax revenue under Biden's tax proposals would come from people in the top 1% income group. However, they also concluded that, by 2030, the "bottom 99 percent of taxpayers would also face modest tax increases" attributable to business tax increases. According the Committee for a Responsible Federal Budget, the bottom 80% of American taxpayers will only see a tax hike of 0.2% to 0.6% of after-tax income. Similar conclusions were reached by the Penn Wharton Budget Model and Tax Foundation. So, while most families (82% is the figure most often used by the Trump team) are expected to see an indirect tax increase, the additional tax amounts are expected to be relatively small.