Top 4 Biden Tax Changes That May Affect You

October 6, 2020

Presidential Democratic nominee, Joe Biden, recently released more information on his proposed tax agenda. While there are a number of tax changes that Joe Biden has mentioned, we will focus on four potential changes that would impact individual taxpayers. Of course, these changes are contingent on Vice President Biden winning the election and also being able to pass legislation to implement his tax plan:

1. Increase the top income tax rate from 37% to 39.6%. This is pretty straight forward – for households in the top ordinary income tax bracket, the rate applied to this income would go up.  President Trump passed the Tax Cuts and Jobs Act at the end of 2017 which, in general, lowered brackets overall, including the top ordinary income tax bracket from 39.6% to 37%.  Joe Biden’s proposal would partially reverse the rate cut for top earners.  It should be noted that the tax rate changes implemented in the Tax Cuts and Jobs Act are temporary and set to revert to old levels in 2026 regardless.

2. Long-term capital gains and qualified dividends taxed at 39.6% for households earning $1M or more. Depending on your income, this could be a significant tax increase, going from the current top rate for this income of 20% up to 39.6%.  In addition to these rates (both under current law and Joe Biden’s proposal), there is an additional 3.8% net investment income tax levied on investment income which would remain in place under Joe Biden’s tax plan.

While impacting top earners on an annual basis, this tax change could also impact taxpayers who may experience a large liquidity event, or perhaps a business owner selling company stock.  If selling company stock in 2020, the capital gain income would be taxed at a Federal rate of 20% (plus any state taxes).  However, if selling in 2021 or later, the Federal capital gains rate on that income could jump up to 39.6%.

Planning Idea: For higher-earning individuals, this tax increase could be tough to avoid, but one option could be to convert pre-tax assets to Roth.  Despite paying at the top rate now on that income, one could avoid paying at the top rate of 39.6% later and shift stocks into the Roth account, thus shielding future growth of those stocks and dividends from the potentially higher 39.6% rate.

3. The value of itemized deductions would be capped at 28%. Under current tax law, itemized deductions offset the highest-rate income first.  So, if a taxpayer is in the 37% ordinary income tax bracket and has $100,000 of itemized deductions, those deductions would reduce income in that top bracket and save the taxpayer $37,000 of taxes ($100,000 x 37% = $37,000 taxes saved).  Joe Biden’s proposal would cap the benefit of itemized deductions at 28%.  So that same taxpayer, still in the top bracket of 37%, would only save $28,000 for that $100,000 of itemized deductions ($100,000 x 28% max benefit = $28,000 taxes saved).

Of course, if a taxpayer is in a tax bracket lower than the maximum benefit rate of 28%, any itemized deductions would offset at that specific taxpayer’s top tax bracket.  So, if the taxpayer is in the 24%, any itemized deductions would benefit them at that rate (not the max benefit of 28%).

Planning Idea: One planning idea is to continue to lump itemized deductions (such as charitable giving) into an every-other-year format.  So, if a taxpayer is in the 24% bracket, he or she could lump gifts into one year and perhaps couple that with a Roth conversion so that the itemized deduction benefit is realized at a higher tax rate.  Also, higher earners may think about accelerating both income and deductions.  This would allow the deductions to be worth more in 2020 from a tax rate standpoint as opposed to the benefit potentially being limited to 28% in later tax years if Biden’s proposal were to turn into law.

4. Pease limitation could be re-instated. The Tax Cuts and Jobs Act eliminated the Pease limitation, which reduced the amount of itemized deductions available to taxpayers with income above a certain threshold ($156,900 for single filers and $313,800 for married filing jointly).  Itemized deductions were reduced by 3% for every dollar of taxable income above these thresholds with the phase-out stopping at 80% of the total value of the taxpayer’s deductions.  Joe Biden’s tax plan would re-instate the Pease limitation, limiting itemized deductions for high earners.

As you can see, there a number of proposals in Joe Biden’s tax agenda that could increase the amount of tax being paid by higher earners. While at this point the tax plan is just that, hypothetical and a proposal; however, we encourage each client to understand the potential changes and ramifications for their tax situation. If you would like to discuss any tax planning strategies, please reach out to your BDF wealth management team.