Biden’s Tax Proposals
Below we have compiled several of the critical features of Joe Biden’s tax proposals. We have added commentary to clarify some of the proposals along with the significance of the changes. Please remember these are only initial proposals and there is no time frame for implementation.
• Restoring the top marginal income tax rate to 39.6 percent from today’s 37 percent for those earning over $400,000.
•Taxing capital gains at ordinary income tax rates, an increase from today’s top rate of 23.8 percent for those earning over $1 million.
High-income earners may want to consider accelerating into 2020 planned sales of investments with large unrealized gains. Philanthropic gifting should be done with highly appreciated stock. High-income earners may also want to consider accelerating gifts to beneficiaries by gifting appreciated stock (this is elaborated upon below).
•Eliminate a tax expenditure called “step-up in basis” that allows decedents to pass capital gains to heirs without tax.
Under current rules when a decedent’s securities are passed to heirs the basis or in simpler terms, the price paid for the investment is “stepped up” or converted to the value on the date of death. For example, if a person purchased an investment for $100,000 and it was valued at $200,000 on the day that they passed, the beneficiaries’ purchase price is changed to $200,000. If the decedent sold the investment the day before they passed there would be capital gains taxes due on a gain of $100,000
, if the beneficiary we to sell the security the day after the person passed there would be no capital gains. Biden’s plan would eliminate the step-up. Currently, it is unclear if beneficiaries would be expected to pay the capital gains tax on unrealized gains immediately or if the taxes would be owed as the investments are sold. In either scenario but especially if the taxes are due immediately accelerating gifts of appreciated securities to beneficiaries should be considered particularly with large estates.
•Capping the value of itemized deductions to 28 percent for those in higher marginal tax brackets and restoring the Pease limitation on itemized deductions for those with taxable income above $400,000.
Under current law, taxpayers can claim a $24,800 per-couple standard deduction or deduct from their income the combined cost of mortgage interest paid, charitable giving, state and local taxes (up to $10,000), and certain other itemized deductions. Biden’s tax plan would limit these itemized deductions in two ways. First, Biden would institute an overall cap of 28 percent on the rate against which one could take itemized deductions. So, for example, an individual in the 39.6 percent tax bracket would see a 28-cent tax reduction for every dollar spent on charitable giving, rather than 39.6 cents without the cap.
Additionally, Biden would reinstate the “Pease Limitation”, which was suspended through 2025 under the TCJA, for those with income above $400,000. The Pease Limitation effectively reduces the amount one can deduct above a certain threshold. For every dollar of income earned above the threshold, the Pease Limitation reduces the value of itemized deductions by three cents.
•401(K) and other retirement account contributions will no longer be deductible instead contributions would revive a tax credit equal to 26% of the amount contributed. This may negatively affect workers with incomes below $400,000, as it reduces the benefit of 401(K) contributions for anyone whose marginal tax rate is above 26%
Biden’s proposal would eliminate deductible traditional contributions and instead provide a 26% refundable tax credit for each $1 contributed. The tax credit would be deposited into the taxpayer’s retirement account as a matching contribution. Existing contribution limits would remain, and Roth-style tax treatment would be unaffected. Savers whose marginal tax rate is below 26% should contribute the maximum that they can afford up to the established maximum. Savers whose marginal tax bracket is greater than 26% will be negatively impacted by this change as their current deduction would be greater than the 26% tax credit. Savers whose marginal tax rate is greater than 26% may want to consider Roth 401k contributions (there are no income limitations on Roth 401(K) contributions). Contributing to a Roth 401(k) as opposed to a traditional 401(K) under both the current tax scheme and Biden’s proposed plan would increase current year tax bills however tax savings would be recognized in the future as Roth accounts grow tax-free as opposed to tax-deferred like traditional retirement plans. Additionally, wealthy parents may want to gift funds (or appreciated securities to children or grandchildren for them to sell and pay the capital gains tax on as described above) to children, grandchildren or other beneficiaries that are employed but unable to afford their maximum 401K contribution.
Below are two charts comparing how if implemented these changes can affect a single filer at various income levels when making traditional 401(K) contributions. The first chart assumes that a saver is contributing 10% of their income, the second chart assumes that the saver is contributing the maximum allowable amount.
•Imposing the 12.4 percent Social Security payroll tax on wage and self-employment income earned above $400,000.
For 2020 the maximum limit on earnings for withholding of Social Security (old-age, survivors, and disability insurance) tax is $137,700.00. The Social Security tax is split evenly between employer and employee. Under Biden’s proposed plan the social security tax remains essentially the same for workers earning under $400,000. However, incomes above $400,000 will see significant increases in taxes as any earnings above $400,000 again become subject to the Social Security payroll tax.
- Eliminate the 1031 exchange provision for real estate investors.
A 1031 exchange allows an investor to defer paying taxes on real estate assets when they use those earnings to invest in another, similar property. It is not yet clear weather Biden’s plan would eliminate the 1031 exchange entirely or only for investors with over $400,000 in income. In either scenario eliminating the provision or scaling it back along with the increase in the highest capital gain rate to 39.6% is likely to negatively impact real estate valuations because there could be a decrease in real estate investment, development and overall transaction volume as holding periods of property increase.
•Raising the corporate income tax from 21 percent to 28 percent.
•Imposing a 15 percent minimum book tax on corporations with $100 million or greater in income.
•In addition to increasing the corporate income tax rate to 28 percent, Biden would institute a 15 percent minimum tax on “book” profits, or reported annual income net of annual expenses, for corporations with at least $100 million in annual income.
•Doubling the tax rate on Global Intangible Low Tax Income (GILTI) earned by foreign subsidiaries of U.S. firms, from 10.5 percent to 21 percent.
•Under current law, a Global Intangible Low-Taxed Income (GILTI) tax requires multinational companies to pay a tax of at least 10.5 percent on foreign income generated from relatively mobile and intangible assets held abroad such as patents, trademarks, and copyrights. The size of the tax is based on taxing 50 percent of this income at the current 21 percent rate. Biden would double the GILTI tax from 10.5 to 21 percent. This would presumably be achieved by taxing 75 percent of this income at the new 28 percent tax rate. This policy would raise slightly over $300 billion over a decade.
The proposed changes described above would reduce corporate earnings. Goldman Sachs predicts that Biden’s tax plan would reduce S&P500 earnings by 12% from $170 to $150. At the S&P500s current approximate value of 3,340 the price to earnings ratio would increase from around 19 to 22. JP Morgan predicts that S&P earnings could be reduced by 10% to 15%. In either scenario, the S&P500 would need to fall by a corresponding amount as the earnings reductions to maintain an equal PE ratio. Analysts are split on the immediate impact of a Biden presidency. Some analysts see a market that needs to decrease for three primary reasons, lowers earnings should translate to lower stock prices, increased regulations as well as changes to individual capital gains rates. Currently, an investor that earns over $1 million in income will pay taxes on long-term capital gains at 23.8% for every $100 in gains they keep $76.20 if that rate increases to 39.6% then they only retain $60.40 for every $100 in gains. Some analysts believe that wealthy investors will demand lower stock valuations to offset lower after-tax profits. Other analysts are far less concerned. They believe that investors lack a viable alternative to the stock market, investors may alter their strategy but sitting in cash doesn’t make sense over the long-term. They believe other aspects of Biden’s plan such as infrastructure spending will offset some of the negatives such as increased regulations. Finally, they believe that well-timed tax increases may not be as detrimental as expected. JP Morgan referenced Bill Clinton’s 1993 tax increases and they believe well-timed tax increases, potentially not until 2022 if the economy is on an upswing, could be digested by markets with little negative effects.
Please reach out with any questions about how these changes could impact your personal situation including potential investment implications.