Proposed Tax Changes (and Planning Strategies) Under the Biden Administration
January 14, 2021
Three years ago, one of the most extensive revisions ever was enacted to the Internal Revenue Code. Today, much of this 1,000+-page piece of legislation (The Tax Cuts And Jobs Act of 2017) is still being sorted through and clarified by the Internal Revenue Service.
But it is a new day – we have a new President. And the Democratic Party has a (razor-thin) majority in both the House and Senate. So, what does this mean? Let us discuss what may happen to taxes (and possible planning strategies) in the next few years.
While there are many, many items to discuss (and more than we can cover in a blog post), we can discuss the main topics within these categories:
- Ordinary income,
- Capital gains,
- Estates, and
- Itemized deductions.
President Biden has proposed to increase the ordinary income tax rate for those making $400,000 or more. Biden’s proposal states “anyone” in regard to this threshold and hasn’t yet specified whether this applies to single filers, married filers, or both. So we will assume both until further clarification. We see this in three main ways:
- Rates would be (back) at 39.6%. Not only for the top (37%) bracket but also for those currently at the 32% and 35% brackets for income above $400,000.
- Social Security payroll taxes would be levied . Payroll (FICA) taxes are 15.3% collected on the first $142,800 of wages – half by the employer, half by the employee. While Medicare (2.9%) applies for all wages past this limit, Social Security (12.4%) currently stops at $142,800 (for 2021). Under Biden’s plan, we would see a “donut hole” where income between $142,800 and $400,000 are not Social-Security-taxed, while all other wages (under $142,800 and above $400,000) would.
- The qualified business income (QBI) tax deduction would be eliminated . Owners of certain pass-through entities (e.g. LLCs and S corporations) have previously been allowed a 20% deduction on business income, effectively reducing a 37% tax rate to 29.6%. This kept smaller businesses in line with the lower (21%) corporate tax rate. This change would increase the effective top tax for these pass-through owners by exactly 10%, from 29.6% to 39.6%.
For those with income under $400,000, President Biden has pledged not to raise taxes. However, some of the other areas of the proposal will affect many under this threshold (e.g., estate planning, certain itemized deductions, and credits). We will cover these areas in the weeks ahead.
What are some strategies to consider with these changes?
With taxes likely increasing, it may make sense for many to accelerate income – pay taxes at a lower rate now rather than a higher rate later. The most common example of this is the Roth conversion: taking a Traditional, pre-tax IRA, paying tax on it, and moving it into a Roth IRA. This may make sense to discuss even though it does not make sense for everybody. Other options (for business owners) include using bonus depreciation and installment sales to regulate income.
One major note here: while Congress does not often enact tax changes retroactively, it is within their power to do so (meaning rates could change for 2021, and not just 2022-forward). So with any major changes to income and taxes, it may make sense to wait until there is more clarity on the timing.
In the next few posts, we will discuss each of the other areas (capital gains, estate taxes, and itemized deductions). Our hope is to cover each of these areas so that you will be in a position to make the best decision for your financial future.
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