President Biden, as well as House and Senate Democrats, have proposed numerous tax law changes. We do not expect these changes to take effect immediately since it seems unlikely that any modifications would apply retroactively to the beginning of the tax year. That said, Congress has at times made mid-year changes that were retroactive.
When and if the proposed changes occur, they would involve income taxes, payroll taxes, long-term capital gains taxes, and transfer taxes.
As tax professionals, we strive to educate our clients on changes that may impact them — especially if those changes might require advance planning or immediate action. A front-page article in the New York Times described Biden's proposed tax increase plan as "the largest federal tax increase since 1942." Regardless of exactly when the changes will take effect, it's a good idea to keep abreast of what might be happening and start preparing sooner than later.
Pine & Company CPAs does not think tax law changes, or even tax increases are something to worry about. Rather we believe that all tax law changes provide new opportunities and can be leveraged by proactive planning.
Proposed Changes to Income Taxes
For quite some time, Biden has been proposing that for those making over $400,000, the tax rate should increase by 37%-39.6%. Based on answers from White House Press Secretary, Jen Psaki, in a recent press conference, this tax bracket includes individuals making $400,000 on their own as well as couples who make $400,000 cumulatively.
No personal income tax increases are expected for those earning under $400,000. In fact, Biden has discussed possibly expanding credits for middle and low-income Americans who make less than $400,000.
Restoring the Pease limitations is another proposed change the Democrats want that will increase the tax by reducing itemized deductions such as on charitable deductions by 3% for every dollar of taxable income above a set threshold.
• High earners who can adjust their income accordingly may want to consider strategies to stay under the $400,000 a year threshold.
• Consider making charitable contributions early in 2021 in anticipation of possible decreased tax value of contributions.
Proposed Changes to Payroll Taxes
Biden's new "Once-in-a Generation" infrastructure proposal involves substantial tax increases for corporations and businesses. These increased taxes will partially offset his proposed spending on various initiatives and upgrades.
The changes include modifications to payroll taxes, such as expanding the FICA (Social Security tax) to cause it to apply to earnings exceeding $400,000. This change would create a donut hole with no FICA tax payable on income between $142,800 (for 2021) and $400,000.
Another significant change could be the repeal of the Tax Cuts and Jobs Act of 2017 (TCJA). If this happens, the corporate income tax rate could increase from 21% to 35%. If the TCJA is not repealed, the Biden administration would still seek to increase the corporate income tax rate to 28%.
Another possible change is that some favorable tax treatments applying to real estate might be eliminated, such as Internal Revenue Code Section 1031 exchanges, applying to taxpayers with incomes exceeding $400,000.
• Reconsider holding on to highly appreciated assets and consider selling them instead before the end of 2021.
• Be aware that corporate tax increases could impact the value of stocks.
• Those who own real estate may want to speed up transactions if they are considering receiving Section 1031 benefits.
Possible Tax Rate Increase of Income Subject to Long-Term Capital Gains Tax Rates
The proposed changes also include an acceleration of income subject to long-term capital gains (LTCG) rates. Under the Democrats' plan, LTCG and qualified dividends over $1 million would be taxed at regular rates instead of capital gains rates. This proposed change basically increases the current tax rate from 23.8% to 43.4%, which is more than an 80% increase.
Because our analysis results depend on multiple assumptions, it can be difficult to provide general guidance. That said, some financial experts have given the following advice:
• Either consider harvesting LTCGs sooner at the lower rate or hold properties longer in order to decrease total annual income.
• Consider using installment sales to regulate income.
Potential Changes to Gift and Estate Taxes
Some of the potential changes gift and estate taxes are dependent on the repeal of TCJA and the bringing back of plans made during the Obama administration. These changes include a decrease in the current unified tax exemption, which involves gifts, estates or generation-skipping transfer exemptions.
Eliminating the step-up in tax basis at death is also on the table, but this change seems unlikely in the near future. Taxpayers should note that Biden has not advocated for an inheritance tax rate increase at this time.
Another change could be to back valuation restrictions from the Obama administration as well as impose some new limits on trusts. The affected trusts include grantor retained annuity trusts (GRATS) as well as GST trusts.
• Consider using the full exemptions as soon as possible.
• Look into strategies that may permit transfers made early in 2021 to be modified later to avoid the consequences of a decrease in the exemption.
When it comes to the changes mentioned above, the structure and effective dates are still unknown. Our goal with this guide is simply to make you aware of potential changes that are likely enough to warrant your attention.
The above material contains information and commentary on tax and legal developments that we felt may be of interest to our clients. The preceding is not a comprehensive treatment of the subject matter covered and is not intended to provide legal advice, tax advice, or financial advice. All taxpayers should consult with their own CPA or tax attorney before making any decisions.
1 - A Guide to Potential Tax Law Changes Under Biden (link)