Potential Tax Implications of Biden Administration

I was researching this topic prior to the November 2020 election. At that time, the consensus was that there would be a “blue wave” with Democrats picking up more seats in the House and winning a clear majority in the Senate, in addition to winning the Presidency. (While I will talk about politics a little bit here because I have to, I dislike politics because politicians really only care about themselves and staying in power. More on this and pork-barrel spending in another post.)

As we now know, polling was again not quite accurate this year. Republicans managed to pick up some seats in the House and are close to holding a slim lead in the Senate. It will all come down to if Republicans can win at least one of the two run-off elections in Georgia in early January.

Provided Republicans can win, then the proposed tax changes will likely not happen. And, even if Democrats do win a tie in the Senate with Vice President Harris as the tie-breaking vote, the fact that it was not a blue wave will likely mean that many of Biden’s proposals will not come to fruition as he would need all Democratic senators to vote with him…many are up for re-election soon and I bet they are worried about losing if they swing to far to the left.

Okay. Enough context. Below is a summary of the changes that Biden proposed during the election. Some may have been proposed solely as a means to gain votes and would never actually be implemented…who knows. Like I said earlier, politicians on both sides do not care for us. They only want votes.

Biden’s Tax Proposals

A colleague at work recommended a podcast that compared Trump and Biden’s tax plans. Trump’s essentially being a continuation of the 2017 Tax Cut and Jobs Act and Biden’s a repealing of the 2017 Tax Act with additional taxes added in. I’ve typed out a summary of the conversation on the podcast. Any commentary on there (phrases like “I think”), are just a direct typing of what the interviewee said on the podcast.

The podcast has a target audience of financial advisors for family offices. It doesn’t have any particular political agenda and is just preparing clients for any potential changes to the tax structure. I just wanted to give you a head’s up for any estate planning purposes.

Family Office Connections: A Comparison of the Trump and Biden Tax Plans

Summary of Biden’s proposed tax changes:
(detailed discussion below)

1. $4 trillion tax increase, the largest in the history of the world
2. Higher marginal tax rates (up to 39.6%) kicking in at lower income amounts; the thought is that this would be a revision back to the pre-2017 Tax Cut marginal rates
3. Coupling of ordinary income and capital gains; capital gains for people in the highest income tax bracket would be 39.6% (qualified dividends would no longer be taxed at long-term capital gains rates and would instead by taxed at ordinary income rates
4. Social Security withholding rates currently at 12.4% (employer plus employee) capped at $137,700. Biden proposal is to add additional 12.4% tax for above $400,000.
5. Repeal higher federal estate and gift taxation exemption (currently $11.58 million per person); if 2017 Tax Act repealed, that would drop to $5.8 million per person though the interviewee thinks that the law could revert to $3.5 million or lower and possibly revert to graduated tax rates that could get to as high as 60% (this tax is right now a flat 40%);  the estate tax exemption was going to revert back at the end of 2025 and Trump wants to make the higher amount permanent
6. Elimination of step-up in basis: currently a $100,000 investment that is worth $500,000 at death would reset to a basis of $500,000; Biden proposal is to eliminate this step-up in basis so that this investment would be subject to $400,000 of capital gains taxes (which could be as high as 39.6% PLUS an additional 3.8% net investment income tax since this amount is higher than $250,000).
7. Current corporate taxes of 21% under the 2017 Tax Act…Biden has proposed 28% (worldwide average of the industrialized world is 22.5%)
8. Interviewee says that these things are fluid and not set-in-stone but feels that they would go through should Democrats win the White House and Congress
9. Changes in 401(k): a 26% credit vs a deduction at one’s marginal tax rate; a credit is a direct reduction in the amount of income tax due, versus a reduction in taxable income (which is how it works now)

Detailed discussion of tax plans

Small Business Tax Rates

• elimination or repeal of small business tax rate (199A, which allowed many small businesses that were pass through to use corporate taxes @ 20%)
• increase in capital gains tax rate currently 20% (has been as low as 15% in the last 15 years)

Income Taxes

• Biden has proposed coupling ordinary income and capital gains
• capital gains for people in the highest income tax bracket @ 39.6%
• net investment income tax of 3.8% if modified adjusted gross income over $250,000 (for married filing jointly) (under Trump and Biden’s proposals)
• ↳ level of taxes approaching 43.5%

• differences in itemized deductions
• some deductions would be brought down so that they are effectively up to 28%
• a phase out in itemized deductions as income gets higher
• benefit of removing $10,000 cap on deduction for state and local taxes

Social Security and Medicare Withholding Rates

Currently (Trump’s tax plan): 

• social security taxes paid on earned income, which fade out at $137,700 of income → will adjust to approx $140,000 in 2021 with inflation
• social security withholdings rate: employee 6.2% and employer 6.2% (12.4% total)
• Medicare withholdings: 1.45% for employee and 1.45% for employer (2.9% total)

Biden’s Social Security Tax Proposal:

• same social security tax through $137,700 then no tax from $137,700 through $400,000 earned income
• above $400,000, would pay 6.2% as employee and 6.2% as employer (without a cap)

Private Equity

• nothing announced per se at this point
• capital gains decoupling would be significant
• in many instances an almost doubling of capital gains taxes

Corporate Tax Rates

• prior to 2017, US had one of the highest corporate tax rates (35.7%), though few actually paid at this rate (depreciation, deductions, expenses, etc)
• Trump pushed for corporate tax rates to be at the median of the worldwide corporate tax rates (roughly 22.5% worldwide)
• Trump wanted 20% and eventually settled at 21%
• Biden has proposed 28% (still higher than industrialized world but not back to 2017 levels)
• these are proposals and numbers are not set in stone

* Democrats raising taxes and Republicans lowering is not unusual, what is unusual is the $4 trillion increase, which is largest ever

Estate Tax

• under 2017 Tax Act, the federal estate and gift taxation exemption (amount you can transfer free of estate or gift taxes) is $10 million (indexed for inflation and currently at $11.58 million) per person ($23.16 million per couple)
• husband and wife can each transfer that amount estate and gift tax free

• if repealed, that number reverts to $5 million as indexed for inflation, exemption of roughly $5.8 million per person today
• this is if we just eliminate 2017 Tax Act
• he thinks that if Democrats control House, Senate, and Presidency, estate tax law would revert to $3.5 million or maybe even lower and possible reversion to graduated tax rates prior to 2010s where tax started at 40% and got up to 55%, and, if over a threshold amount, as high as 60%
• right now, tax rate is a flat 40% if transferring amounts greater than the exemption

• if Democrat trifecta, he thinks estate tax exemption will be lowered well below 2017 level and taxes raised
• in addition, Biden has suggested that the step-up in basis at death will be eliminated
• right now, a $100,000 investment that is held for 10 years and is now worth $500,000, would reset for capital gains purposes to $500,000 upon death
• it has been this way for many years

• Biden has suggested no step-up in basis
• using the above example, the $500,000 asset if sold upon death would be subject to $400,000 of capital gains taxes (which would be as high as 39.6% depending on where income levels are) and an additional 3.8% net investment income tax
• an additional problem is that many very longterm investments were prior to accurate record keeping and initial basis is difficult to know (this adds a significant compliance cost)

• estate tax exemption was going to revert back at the end of 2025
• Trump wants to make this permanent

Three Legs of the Trifecta Stool

1. transfer assets to an “access trust,” higher exemption amount can be locked in place now 
   • if transfers are made now, funds can be accessed via distributions but are not included in his or her estate
2. with recent volatility, particularly on the privately held business ownership interests, valuations have come down
   • valuation disconnect due to Covid-19
3. we now sit at historic low intrafamily leading rates
   • right now if money is lent to a trust for a junior generation or directly to a junior family member, they can do so for a 3-9 year loan at as low as 0.41%

• Biden presidency would likely remove two of these three legs

The Make Billionaires Pay Act

• bill introduced by Sanders
• very, very little chance of this passing but theme is becoming more common
• Sanders has identified 467 billionaires in the United States and his proposal is to tax 60% of the wealth gain of those individuals from March 18th (supposedly peak Covid-19) through end of the year
• what gets dangerous here is a diversion from taxation only when income is earned and capital gains on assets when we sell them
• there would be a tax here regardless of selling
• this would be the first “mark to market” tax

• he doesn’t believe this would happen but New York is implementing something similar and there are a lot of state and local governments talking about increasing taxes

State Taxes

• for example, in California (highest state income in the country at 13.3%), they are proposing a 1% surtax on top of that if making more than $1 million, 3% surtax if making over $2 million, and 3.5% surtax if making over $5 million

• someone in California that makes over $5 million is looking at a 16.8% state income tax coupled with a 39.6% federal income tax, total tax rates of 54% to almost 57%
• states that have had trouble managing fiscal responsibilities are turning to tax the high income earners
• local tax in Nashville, TN just increased property taxes by 37% to cover shortfalls

• I think this is a very dangerous strategy coming out of this pandemic
• in a business environment where many people have found that they can work effectively from home AND state and local governments raising taxes, many people will move and entrepreneurs will move their businesses

• why stay in California when it is 16.8% when it is 0% in Nevada or Texas or Florida
• the billionaires are the ones most capable of-moving if a state like California or New York raises its taxes → a very dangerous scenario for some states

Actions to Take

• when it comes to these proposals, where it starts and where it ends is very fluid
• for families that are thinking of using these higher estate and gift tax exemptions, your window to use this these will close very, very quickly if a Biden presidency, but you are going to be hard pressed to find counsel to help you implement these strategies because of the limited timeframe to act in
• this needs to be put on the front burner because there are not enough people to help families if there is a 2-3 month time crunch

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Biden’s Proposed Change to the 401(k) Plan

• currently if you pay the top 37% tax rate and contribute the maximum (currently $19,500 under 50 years old), you would receive tax benefit of $7,215 (or $7,722 tax benefit using the law prior to the 2017 tax act)
• someone in the 22% tax bracket would receive tax benefit of $4,290
• someone in the 12% tax bracket would receive tax benefit of $2,340

• Biden’s proposal is for a 26% credit of the contribution amount
• someone contributing the full amount would receive a tax credit of $5,070
• the credit is income agnostic
• a credit is a direct reduction in the amount of income tax due, versus a reduction in taxable income (which is how it works now)

• some people feel that a consequence of this would be to move more people toward a Roth 401(k)
• this move would have the secondary consequence of boosting tax revenues right away as more wealthier people pay taxes upfront and stop deducting their 401(k) contributions  

Sources: 

1. https://www.marketwatch.com/story/will-bidens-401k-plan-help-you-or-hurt-you-2020-09-09
2. https://www.thestreet.com/financial-advisor-center/what-bidens-401-k-tax-plan-could-mean-for-investors

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