The Election and Taxes: What if Biden Wins?

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With the Presidential election less than two weeks away, many people are starting to wonder what they should be doing with regard to income tax and estate planning in case Joe Biden is elected President.

For the vast majority of people, the answer — at least right now — is: Nothing. While a Biden Presidency would no doubt lead to changes in tax policy over time, there are still too many uncertainties to justify making any drastic changes to income tax and estate planning strategies at this time.

Proposed Tax Changes

The Biden campaign has announced some of the changes a President Biden would make when it comes to income taxes and estate taxes. These include the following:

  • Increase the top marginal income tax bracket (and presumably trust bracket) from 37% to 39.6%. While the top marginal bracket is scheduled to revert to the pre-Tax Cuts and Jobs Act level of 39.6% after 2025, the 39.6% marginal bracket could materialize next year.
  • Increase long-term capital gains and qualified dividends rates for taxpayers earning more than $1 million. Taxpayers with income (presumably adjusted gross income) over $1 million would pay ordinary income tax rates (39.6%) on long-term capital gains and qualified dividends, instead of the current 20%.

In addition, the 3.8% net investment income tax (NIIT) would also still exist. Once state income taxes are incurred, the total tax liability could be 50% on long-term capital gains and qualified dividends.

  • Decrease the unified credit (or estate/gift exemption) from $11.58 million per decedent this year to $3.5 million (or $5 million per decedent), plus potentially some inflation adjustments.
  • Eliminate valuation discounts, which could be more detrimental for some taxpayers than simply decreasing the exemption by $6 million-$8 million.
  • Eliminate the step-up in basis. It’s not clear if the heir would simply carry over the decedent’s basis or if capital gains would be incurred at the time of death.

Note: Implementing mark-to-market capital gains, which would tax high earners annually on unrealized capital gains, has been proposed by some Democrats but is not part of the Biden tax plan.

Under-the-Radar Changes

In addition, here are some less-publicized income and estate tax changes that are included in the Biden tax plan:

  • Earned income up to $400,000 would be subject to the Social Security payroll tax (this is currently capped at $137,700). This income would be subject to the 6.2% tax (or 12.4% for the self-employed).
  • Elimination of the qualified business income (QBI)/Section 199A deduction for taxpayers with income (presumably AGI) over $400,000, regardless of the type of business. This could effectively increase taxes on pass-through income by 10% — from 29.6% to 39.6%.
  • Increase the flat corporate tax rate from 21% to 28%.
  • Eliminate Section 1031 exchanges for taxpayers with income (presumably AGI) over $400,000.
  • Limit charitable deductions for taxpayers with income (presumably AGI) over $400,000 to a 28% tax rate.  For example, if a taxpayer in the new 39.6% bracket gave $10,000 to charity, his deduction would be .28 x $10,000 = $2,800, instead of $3,960.
  • Implement a 26% (approximate) tax credit that would replace deductions for contributions to retirement accounts. The intention here is to give high income earners in high tax brackets who deduct retirement plan contributions the same net tax benefit as those in lower tax brackets. Contributions to Roth accounts would presumably be unaffected.

Some taxpayers have voiced concerns that changes like these could be implemented early in 2021, However, it’s more likely that any changes wouldn’t be passed until later in the year, though they could be made retroactive to January 1, 2021. Of course, passage of changes like these would probably require that Democrats also regain control of the Senate. If Republicans retain the Senate, passage of major income tax and estate tax changes would be less likely.

Potential Impact at Different Income Levels

Various sources such as the Tax Policy Center, Tax Foundation, Penn Wharton Budget Model and American Enterprise Institute have estimated the potential impact of the Biden tax plan on individuals and families at different income levels:

  • Taxpayers with AGI under $250,000 (married filing jointly) could incur less than a 1% increase in income taxes.
  • Taxpayers with an AGI of between $250,000 and $400,000 (married filing jointly) could incur between a 2% and 6% increase in income taxes.
  • Taxpayers with an AGI of more than $400,000 (married filing jointly) could incur between a 12% and 18% increase in income taxes.

What to Do Now?

For now, most people will probably be better off sitting tight and not making any drastic income or estate tax planning moves. This includes high earners, though they should probably prepare to make some moves sooner rather than later.

For example, high and very high earners who could face a top ordinary income tax rate of 39.6% and a loss of step-up in basis might want to consider accelerating capital gains into this year. This way, a tax rate of 23.8% could be paid this year and the basis reset — the position could even be immediately bought back. Next year, capital gains could be taxed as high as 43.4% for high earners.

Another strategy to consider is charitable “bunching” via a donor-advised fund. Bunching charitable deductions this year and receiving a dollar-for-dollar reduction in taxable income (even if “only” at 37%) could be beneficial. While a tax deduction in the potential 39.6% marginal tax bracket next year is more valuable than a 37% deduction this year, there is also substantial risk that a 39.6% deduction could turn into a 28% deduction due to the proposed charitable giving cap described above.

Please feel free to contact us if you have more questions about your specific tax situation.

The commentary is limited to the dissemination of general information pertaining to Frontier Wealth Management, LLC's ("Frontier") investment advisory services. This information should not be used or construed as an offer to sell, a solicitation of an offer to buy or a recommendation for any security, market sector or investment strategy. There is no guarantee that the information supplied is accurate or complete. Frontier is not responsible for any errors or omissions, and provides no warranties with regards to the results obtained from the use of the information. Nothing in this document is intended to provide any legal, accounting or tax advice and Frontier does not provide such advice. This information is subject to change without notice and should not be construed as a recommendation or investment advice. You should consult an attorney, accountant or tax professional regarding your specific legal or tax situation.

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