A Biden Administration Could Significantly Impact Income Taxes

Throughout the election, former Vice-President Joe Biden made it clear that if elected, he planned to raise taxes on those earning $400,000 and above. To date, the election results are not finalized, especially control of the Senate.  If the Democratic Party were to become the majority in the Senate, it is likely Mr. Biden would pursue the tax legislation he campaigned on.

Biden’s stated goals are to raise additional tax revenue for a variety of reasons.  Below are some of the more significant changes cited:

• Generating more payroll taxes
  • Expanding taxable wages and earned income subject to social security
• Increasing the individual income tax revenue
  • Raising marginal rate income tax rates
  • Minimizing the benefit of 199A Qualified Business Income (QBI) deduction
  • Reducing the benefit of itemized deductions (ex. charitable contributions)
  • Eliminating the preferential dividend and capital gains rates
• Dramatically changing wealth taxes on estate and gift
  • Lowering Estate exclusion before the 2026 sunset
  • Decoupling the gift tax exclusion
  • Abolishing the “step-up” in basis of assets owned at the date of death
  • Instituting a gift tax on appreciated assets transferred during lifetime
• Increasing the C corporate income tax rate

Below is a closer look at how some of these policies could increase tax burdens and planning ideas for potential mitigation strategies.

Generating More Payroll Taxes

There has been considerable talk that the Biden Administration would like to eliminate the cap on social security wages which is set at $137,700 for 2020.  Under this initiative, an individual’s earned income greater than $400,000 would be subject to social security tax (6.2% for the employee and 6.2% for the employer).  For self-employed individuals and some with deferred compensation arrangements, this would be a 12.4% increase on earned income greater than $400,000.

PLANNING IDEA: many taxpayers are evaluating accelerating non-qualified stock options and deferred compensation into 2020 hoping to avoid this potential additional 12.4% tax.  Many are also reevaluating the use of an S Corporation structure and the distributions above and beyond reasonable compensation to avoid the same tax.

Increasing Individual Income Tax Revenue

The most talked-about impact of Biden’s plans would be returning the marginal tax rate for those earning $400,000 or more to 39.6 percent from the current 37 percent.  However, that is not the end of possible changes to increase revenues.

• The 199A deduction provides rate relief for qualified business income to match corporate rates for certain self-employed income, rental, and pass-through income. The benefit of this deduction is rumored to be maxed out at $400,000 of income would place the rental and pass-through income on the same level as the earned income and severely limit the benefit for those investing in LLCs and S corporations.
• There are objectives to minimize the benefit that higher earners gain from itemized deductions and increase their effective tax rates. The two most discussed ideas are to limit the benefit of any itemized deductions to 28% (vs. the marginal tax rate of the individual) and reinstituting the Pease Limitation which reduced itemized deductions by 3% when income exceeds a limit.
• In 2020, there is a 20% marginal tax on long-term capital gains and qualified dividends. Many Biden proposals are centered around eliminating this preferential rate once an individual is over $1 million of income.  The preferential rate would then be eliminated, taxing this income at the 39.6% marginal tax rate.  This could double the income tax on these earnings.

PLANNING IDEAS: many taxpayers are evaluating accelerating income in 2020 to avoid these potential increases.  There has been considerable talk that bundling a few years of charitable contributions into 2020 into a donor-advised fund may be beneficial.  There has also been considerable talk about the benefits of Roth conversions in 2020.

Increased Wealth Taxes on Estate and Gift

Another goal of those running for president from the Democratic Party in 2020 has been to curtail the generational transfer of wealth as this further disenfranchises the middle class.  The intersection of increasing the tax burden “on those who can afford it” and the desire to reduce the transfer of wealth are the proposals related to estate and gift taxes.

In 2020, U.S. citizens can exclude approximately $11.6m ($23m for couples) of wealth estate tax-free which is also the lifetime gifting threshold.  We know that many of the modifications under the Tax Cuts and Job Act (TCJA) terminate at the end of 2025 and this estate exclusion will revert back to the 2009 levels (which would be $3.5m per person or $7m per couple).  Including the estate exclusion, there are several proposals that have been presented by the Biden Administration that would dramatically change wealth taxes in the United States.

• Accelerating the termination of the TCJA exclusion amount so decedent’s estates would be subject to estate tax at a much lower level (much discussion focused on $3.5m per person or $7m per couple). This will significantly increase the number of families that will be subject to estate tax.
• Increase the maximum estate and gift tax rate from 40% (under TCJA) to 55% (pre-TCJA rate). This will dramatically increase the wealth transfer taxes on those estates over $3.5m ($7m per couple).
• Eliminate the step-up of income tax basis – historically, a decedent’s estate is provided a step-up in income tax basis to the date of death value for most all non-retirement and non-annuity assets. In short, the gain on the unrealized appreciation on closely-held businesses, stocks and real estate goes away.  The elimination of the income tax basis step-up would essentially institute a capital gain tax on the estate or the heirs.  This could be compounded by the previously mentioned elimination of the preferential capital gains tax rate over $1m.
• Change the gift tax rules that would (a) decouple the gift and estate levels and (b) potentially trigger capital gains on any appreciated property gifted. If the estate and gift tax exclusion levels are decoupled, it will freeze the gift tax exclusion level to limit the amount that can be gifted in the future.  If there is an elimination of the “Step-up” at death, there has been talk that all gifts of appreciated property should then trigger a capital gain.  So, a gift of appreciated property will effectively then be a sale to done and trigger a tax.

PLANNING IDEAS: many high net worth taxpayers are accelerating gifts to heirs back to 2020 with the anticipation that the exclusions will be reduced and the elimination of the “step-up in basis” may result in significant income taxes to heirs.

Corporate Tax Increase

Currently, the TCJA has set the C corporation tax rate at 21% down from a maximum rate of 35%.  The Biden proposal would increase this rate to 28%.  Note, that S corporation’s pass their taxable income out to the shareholders who then include this in their personal returns.

PLANNING IDEA: this change will impact those C corporations who observed a significant change under TCJA.  This change will increase the incentive to convert to S corporation where possible.

Looking ahead

With the control of the U.S. Senate uncertain until January 2021, there are great unknowns about what changes will be implemented in 2021 under a Biden Administration. As we described, the Democratic Presidential candidates focused on increasing the tax liability of “those who can afford it” and limiting the ability to transfer wealth.  In short, the more control the Democrats get, the more likely there will be significant changes.  While we outlined some of the more prominent changes discussed, there is a litany of other Democratic proposals not addressed in this summary.  There are strategies to proactively address some of these possible changes and most of those relate to 2020 actions.  We recommend discussing options with a trusted financial advisor who is familiar with your circumstances.

Meanwhile, the Boyer & Ritter team continues to monitor how the political landscape may impact tax strategies. We are ready to help you preserve your hard-earned wealth and find the best ways to benefit your heirs and preferred charities.

Thomas J. Taricani, CPA/ABV, CVA, CEPA, is a principal of Boyer & Ritter providing audit, accounting, tax, and consulting services. His specializations include formulation and implementation of succession and estate plans, and preparation of business valuations of closely held businesses for use in succession, estate planning, and various litigation engagements. Contact Tom at 814-234-6919 or ttaricani@cpabr.com.