Barnes Wendling’s Insights on President-elect Biden’s Tax Plan as it Impacts Individuals and Businesses

It appears the country will see a change of administrations in January, as President-elect Joseph R. Biden Jr. has garnered both the popular vote and electoral majorities. While the vote counting continues, it does not appear there will be any change in the outcome of the 2020 presidential election.

Following is an examination of the major provisions of President-elect Biden’s proposed tax agenda, which we first published in August along with insights from Barnes Wendling’s advisors – “BW Thoughts.”

It is important to remember two things. First, policy priorities put forth during presidential campaigns do not always become law after an election. We will keep you informed as to the progress of any tax proposals the new administration pursues.

Second, it is unknown at this time whether President-elect Biden will be working with a split Congress – a Democrat-controlled House and Republican-controlled Senate. Currently, the Senate has 50 Republican members and 48 Democrats. But two U.S. Senate races in Georgia are headed for a runoff election in January 2021. The outcome of those runoffs will determine the balance of power in the Senate. Regardless of which party is in control, the partisan split in the Senate will be close enough that any proposed changes to tax policy will have to be negotiated and wrapped in compromise in order to survive the legislative process and be signed into law.

With that in mind, we thought this would be a good time to revisit the Biden tax plan and our BW Thoughts recommendations.

PRESIDENT-ELECT BIDEN’S TAX PLAN

The key points of the Biden tax plan and Barnes Wendling’s planning suggestions for individuals and corporations are outlined below:

• The new top marginal rate for individuals would return to 39.6% and the lower rate of 37% put into place with the 2017 Tax Cuts and Jobs Act (TCJA) would no longer be applicable. Under current law, the 37% rate was set to expire in 2026. Biden’s plan will restore that rate immediately for individuals making over $400,000.

BW Thoughts: In essence, if your taxable income as an individual is above $400,000, then all your income over the $400,000 benchmark is taxed under the new rate structure. If your income is below the $400,000 benchmark, your tax rate would remain unchanged from the current law.

• An ordinary income tax rate of 39.6% would apply to capital gains and dividends for households earning more than $1 million of income. This same tax rate also would apply to qualified dividends. Currently, capital gains and qualified dividends are subject to a maximum 23.8% tax rate at this income level.

BW Thoughts: An increase in the tax rate applicable to capital gains and dividends will likely see rapidly increasing sales of appreciated stock prior to the end of 2021 and rebalancing of portfolios to potentially include more tax-exempt securities for investors who traditionally receive a significant amount of dividend income.

• The “Pease Limitation,” suspended through 2025 under the TCJA, would be reinstated for taxpayers with incomes above $400,000. This means itemized deductions would only fully benefit taxpayers in the 28% tax bracket or lower. For taxpayers within the higher rate brackets, the tax benefits for itemized deductions would be capped at 28% even with income taxed at 39.6%. The Pease Limitation reduces the amount a taxpayer can deduct above a certain threshold and can reduce allowable itemized deductions to zero.

BW Thoughts: More planning may be required for taxpayers who historically bunched their charitable deductions or contributed to a Donor Advised Fund to ensure itemized deductions are maximized in lower tax bracket years.

• The Qualified Business Income (QBI – Sec. 199A) rules created by the TCJA would be phased out for taxpayers with taxable income over $400,000. Currently, the QBI deduction can lower the impact of flow-through entity income from 37% to potentially 29.6%, and there is no income limit currently in place for this deduction.

BW Thoughts: Taxpayers with pass-through entities impacted by this phase-out may want to consider whether a C Corporation structure would be more beneficial if they will not be eligible for this business income deduction.

• Corporate income tax rates would increase from 21% to 28%. Corporations with profits more than $100 million would be subject to a new Alternative Minimum Tax. This new Alternative Minimum Tax would institute a 15% minimum tax on “book” profits or reported financial statement income for corporations.

BW Thoughts: Corporations may want to take into account the effect of the increased dividends rates of 39.6% for their shareholders as well as the 7% increase to the corporate level income tax when considering a potential change in the structure or future sale. The impact of increased taxes both at the individual level and corporate level will have a negative impact on business valuations and the market to sell a business. This is because the cost to run the business is higher due to the increase in yearly taxes as well as additional costs incurred to owners when the business is sold.

• The “step-up in cost basis” would be repealed. Under current law, when one generation inherits assets from another at death, assets owned by the decedent generally are “stepped up” to fair market value (FMV) at the date of death. As a result, when the beneficiaries sell these assets, the gain or loss that is calculated is the fair market value on the date of sale less the fair market value basis that the asset was “stepped up” to on the date of the decedent’s death. The step-up permitted under current law often results in little to no capital gains tax and the unrealized gain on these assets escapes taxation permanently.

BW Thoughts: It is unclear whether the original basis will still apply, leaving the unrealized gain intact until the beneficiary sells the assets, or if the assets will be taxed at death prior to transfer to beneficiaries. Absent the “step-up” provision, long-held assets would be subject to potentially large amounts of tax especially with the elimination of preferential capital gains rates.

• The estate tax exemption would be lowered from the current $11.58 million to $5 million per individual. Taxable estates would be subject to a progressive structure with rates of 45% ($3.5 million to $10 million), 50% ($10 million to $50 million), 55% ($50 million to $1 billion) and 77% (over $1 billion). The IRS has stated gifts made under current law would not “rolled back” if the exemption amount is lowered.
• The Biden tax plan also would eliminate the step-up in basis on all assets (except for assets that are income in respect of decedent) upon the death of a taxpayer.

BW Thoughts: A reduced estate tax exemption would suggest high net worth families should gift sooner rather than later. The higher estate tax exemption allows for better planning to transition to the next generation of business owners. Moreover, given the impact of COVID-19, valuations may be significantly lower, meaning more value could be passed to future generations.

• Payroll taxes of 12.4% would apply to wages more than $400,000. Under current law, the taxable maximum is $137,700 in 2020. This is intended to raise revenue and close the Social Security solvency gap.

BW Thoughts: An additional payroll tax applied to wages of more than $400,000 may cause some businesses to consider restructuring the wage income paid to owners while ensuring the salaries remain reasonable.

• The federal minimum wage would rise to $15 per hour.

BW Thoughts: The federal minimum wage was last raised in 2009. This proposed raise in minimum wage would increase payroll costs for businesses in all industries and, as a result, we expect many businesses would revisit their staffing levels and efficiencies in processes to ensure employees are paid appropriately.

In addition to the measures above, the Biden tax plan includes the following:

• Raises the child and dependent care tax credit to $8,000 for one child and $16,000 for two or more children for taxpayers with income up to $125,000 per year. The credit phases out for income between $125,000 and $400,000 per year.
• Enacts a refundable tax credit of up to $15,000 for first-time homebuyers.

Remember, often what is planned in political platforms early in the process is very different from what may be the final tax rules. However, any of these proposed changes could have significant economic effects on both individual and corporate taxpayers.

If you have further questions regarding how President-elect Biden’s tax proposals could impact your tax situation, please contact us today.