With the election in November creeping closer, the campaign season is now in full swing. And the closer we get, the more details & campaign promises start to emerge from the candidates.
Biden’s tax plan has mostly flown under the radar in the national media thus far, thanks to the global pandemic. But given that he has at least a 50/50 shot at winning, I thought it made sense to devote a post to what he has in mind if he does win the Presidency. If elected, we could see some substantial changes to the tax code in the next few years.
Here’s the rundown.
The Biden Tax Plan
Unsurprisingly, Biden’s tax plan is more progressive than what’s in place now. He’d like to apply broadly higher income and corporate tax rates, mostly for higher income earners. Biden’s plan also includes greater incentives and credits for various items like child & dependent care, electric vehicle usage, and solar installment. The details of each of these is beyond the scope of this post, but suffice it to say that the plan includes incentives similar to those under Obama. Here’s the summary of his other intiatives.
At the moment the highest tax bracket sits at 37%. This is down from 39.6% prior to Trump’s tax law changes. Under Biden’s plan, the highest bracket would jump back up to 39.6% for individuals with over $400,000 in taxable income. Additionally, the Section 199A QBI deduction would be phased out once taxpayers reach that level.
Recall that when the Tax Cut & Jobs Act of 2017 was passed, the rhetoric revolved around “simplifying the tax code”. Republicans wanted to enable us to file our taxes on an index card, as opposed to the complicated system of forms we were using previously. I wouldn’t say they accomplished that objective, but perhaps they made some progress. One of the “improvements” was to eliminate or limit a number of itemized deductions, and replace them by doubling the standard deduction.
By doing so, far more Americans ended up taking the larger standard deduction. Without itemizing there’s no need to file Schedule A, making your tax return less complex (theoretically). Biden’s plan includes a cap on the benefit of itemized deductions at the 28% rate. For taxpayers in the 32% and 35%, and 37% brackets, this could be a bit painful.
Capital Gains and Qualified Dividends
The current rules provide favorable tax treatment for capital gains of investments held longer than one year, and for qualified dividends. These tax preferences would be preserved under Biden’s plan, but revert to ordinary income tax rates for those earning over $1 million.
Student Loan Forgiveness
Currently, student loan debt in the federal system that’s forgiven is counted as taxable income. This does NOT apply to the public service loan forgiveness (PSLF) program, which is forgiven tax free. After making 20 years of qualifying payments under one of the income driven repayment systems for undergraduate loans (25 for graduate school loans), federal student loan debt is wiped away. As great as this is, under the current law it all counts as taxable income. Biden wants to exclude this forgiveness from taxable income, which would be wonderful news for borrowers.
401(k) plans and other types of employer sponsored retirement accounts have long been sacred cows of the tax code. Not only are contributions tax deferred, they don’t even show up as w-2 income in the first place. This is helpful for a number of planning reasons.
It also means that higher income households tend to benefit more from the contributions than lower income people. For example, a household in the highest tax bracket contributing $10,000 to a 401(k) plan would save $3,700 ($10,000 * 37%) in taxes thanks to the deferral. But a household in the 12% bracket would only save $1,200 ($10,000 * 12%).
Biden wants to change the way contributions to such plans are handled. Instead of deferring taxes on contributions, Biden’s proposal is to provide a 26% refundable tax credit for every dollar contributed instead.
Effectively, this means that your taxable income wouldn’t be impacted by 401k or other retirement plan contributions whatsoever. You’d calculate your taxes due, and then reduce that amount by the credit produced by your contributions. Which would accrue at the same rate for all tax brackets, regardless of your income.
This would be a substantial change to the way 401k plans are handled currently, and it’s one that hasn’t gotten a lot of attention yet. I should note though that this doesn’t mean 401k plans would go away, nor does it mean that you’d want to stop contributing to one. It’d just be a progressive change, and another reason high income households would want to rethink their tax strategy.
Prior to Trump’s Tax Cut & Jobs Act of 2017, the first $5 million of an estate left after death was exempt from estate taxes. The TCJA of 2017 doubled this exemption to $10 million, and it’s been stepped up to $11.58 million for 2020. This hiked exemption amount is scheduled to sunset after 2025, and Biden’s plan would allow that to happen.
More relevant to most Americans, Biden also wants to eliminate the current “step up” in basis we receive on inherited assets. Under the current rules, those shares of AT&T your grandfather bought 70 years would receive a step up in basis if you inherited them from him after death. Which is a wonderful opportunity to reduce tax, since they would have appreciated considerably over the years. Without the step up, you’d owe capital gains taxes if you decided to sell the shares after inheriting them.
Using the step up in basis to your advantage is a very common estate planning technique. If Biden takes it away, hundreds of thousands of estate plans across the country will need to be revisited.
As you may know, if your work falls under the purview of the Social Security system, you’ll contribute to the system through Social Security taxes. Currently Social Security taxes (or OASDI – old age, survivor’s, disability insurance) totals 12.4%. Half of that is paid by employees, half by employers. Biden has raised the possibility of maintaining the same rate of taxation at 12.4%, but changing the taxable wage base.
In 2020 we are only assessed Social Security taxes on the first $137,700 of our earned income. Anything we make above that amount is exempt. Biden has discussed keeping the existing wage base of $137,700 (which is raised a tad each year), but also taxing wages above $400,000. Wages earned between $137,700 and $400,000 would not be taxed.
Corporate Tax Rates
A major initiative in Trump’s tax plan was to make the US a more “business friendly” country, by lowering tax rates on businesses across the board. As part of this, the corporate tax rate was reduced to a flat 21% and the corporate alternative minimum tax was repealed. Remember that this only applies to C-corporations, not pass through entities like S-corporations, partnerships, and LLCs. Taxes on those types of businesses are passed through to owners, and assessed at their personal tax rates.
Biden’s plan would maintain the flat corporate tax rate, but hike it from 21% to 28%. He also wants to reinstate corporate AMT on profits above $100 million.
Impact on Revenue
The impact of such a plan on federal tax revenue, the economy, and our pocketbooks is really the grand question here. The Committee for a Responsible Federal Budget estimated the plan would raise $3.35 trillion to $3.67 trillion over the next decade if enacted in full in 2021. This would be a good thing, given the increasing federal debt levels that I’m growing more concerned about.
Remember though that this is simply the plan Biden has communicated thus far. There are likely other initiatives that would be included in potential legislation that haven’t been fleshed out yet, and there will be a large amount of “horse trading” among the provisions of his current plan anyway. In short, it’s very unlikely the plan spelled out above will become law in it’s current form.
Remember too that we don’t want to put much effort into evaluating the provisions of Biden’s tax plan yet anyway. Not only would the details of plan change through the legislative process, he obviously needs to get elected in the first place.
That said, we could see some pretty substantial changes if he does get elected in November. The biggest for most of us would likely be the retirement plan credit system. It’d still make retirement plans like 401(k)s very attractive vehicles for retirement savings, but high income earners would probably want to rethink their strategy.