Updated: Jun 30, 2021
A new Presidential administration brings change, and tax changes are at the forefront of President Biden’s agenda. While some of these proposals have already made it through the House Ways and Means Committee and some of these proposals have yet to be presented to Congress, one thing is certain: change is coming.
The drivers behind the proposed changes can be traced back to President Biden’s campaign:
Redistribution of wealth to make sure the rich pay their fair share
Rebuilding of the middle class
Elimination of poverty
We are not here to argue the strength or the weakness of the plan, we are here to help you, our clients, pro-actively prepare for the changes that are likely to come.
We will start with a quick summary of the items we think are most relevant, and then break down a few of these items today with more to come in the future. FYI – when we use the term “impact” below, we are referring to their collective impact on the economy and tax payers.
High Impact Changes
Higher tax rates for higher earners
Additional Social Security Tax on Earnings Over $400,000
Increase the capital gains tax rate on incomes over $1 million
Elimination of the step-up in basis at death
Reduction of the tax-free estate value from $11.7 million to $3.5 million
Financial Transactions Tax
Medium Impact Changes
Increased Child Tax Credit
Lowering of the Medicare eligibility age from 65 to 60.
Shifting the benefit of retirement contributions to favor lower earners
Lower Impact Changes
Tax benefits to those who purchase long-term care policies
$5,000 tax credit for Caregivers
Employer credits to companies who offer retirement savings accounts
Increased incentives to promote greater participation levels in retirement accounts
Additional protection of defined benefit plans
Increase in tax rates
Under current proposals, the top tax rate would increase from 37% to 39.6%. This would reinstate the previous top tax rates that were in place back in 2017. This top tax bracket would begin for Single and Head of Household filers making over $452,700, and Married-Filing-Jointly couples making over $509,300. In addition to increased tax rates, this change would also lower the income threshold for the highest tax bracket (they are currently $518,400 for Single and HoH filers, and $622,050 for MFJ couples).
Longer Lasting Child Tax Credit Increase
One item that will help the middle class and doesn’t directly hurt higher earners is the increased child tax credit. For more details on this 2021 tax item, click here. A proposal to expand this credit through 2026 has a high likelihood of passing. Although this proposal doesn’t adversely affect many filers, it has a diminished impact on individuals with incomes above $75,000 and families with incomes above $150,000.
Large Increase in Capital Gains Rates
Currently, capital gains are taxed at 0%, 15%, or 20%, depending on your ordinary income tax bracket. Under Biden’s new proposals, filers with $1 million or more of taxable income would see their capital gains tax jump to the 39.6% tax bracket, nearly double what it is today.
Combining this tax with the Net Investment Income Tax would cause the capital gains tax to be higher than any other rate over the last 65 years.
Change in Estate Planning
Currently, any unrealized gains or losses at your death are “stepped up” to the current fair market value, so that anyone inheriting your property does not have to pay taxes on the gains of inherited property. One of Biden’s newest proposals is to get rid of this exemption amount, and require capital gains tax to be paid on any property over $1 million. Families with elderly parents who have an estate worth more than $1 million will need to pay attention to what happens here.
Consider the following example:
An individual with $2.5 million of taxable assets with a taxable basis of $1.0 million passes away.
Under current rules, the $2.5 million of assets will be passed to heirs with no tax consequence.
The $1.5 million gain is essentially eliminated at death.
Under the Biden Proposal there would be capital gains tax of almost $400,000 before the estate gets passed to heirs.
The first $1.0 million of gains would be taxed at 20%, and the remaining $500,000 would be taxed at the 39.6% rate (see capital gains tax increase above).
Current tax law allows $11.7 million to be passed to heirs with no tax implications.
President Biden’s proposal would create a $400,000 tax bill on this $2.5 million estate, and this estate doesn’t even hit the proposed lifetime exclusion limit of $3.5 million.
Additional Social Security Tax
President Biden’s proposals include an increase in the social security tax on individuals earning over $400,000 while increasing benefits for lower-income retirees. This small policy change essentially shifts Social Security from an insurance program to a welfare program by raising the minimum benefits for low earners.
Social Security is currently projected to run out of money between 2033 and 2035. Raising the tax on a very small percentage of higher-earning individuals improves the solvency of Social Security, but offering additional benefits to a much larger group of recipients dramatically increases the risk of insolvency.
Additional Medicare Surtax
Currently, there is an additional 3.8% surtax titled the Net Investment Income Tax (NIIT). Under current rules, if investment income exceeds $200,000 ($250,000 for Married-Filing-Jointly Couples), then an additional 3.8% tax on all investment income kicks in, on top of other income tax rates. Biden’s new tax proposal expands the 3.8% Net Investment Income Tax on anyone making over $400,000, regardless of the source of income.
The Bottom Line
While the currently proposed tax changes disproportionally affect higher earners, the real risk is that less than 1% of Americans make over $400,000 a year. When Congress and the Biden Administration realize that raising taxes on 1% of Americans is not likely to move the needle, they will have to increase taxes on lower-earners. As our legislators are forced to move down the food chain and raise taxes on more American tax payers, the middle class will eventually be affected. The additional $6 trillion of national debt that the taxpayers took on over the last 16 months will be a burden to all taxpayers, not just the top 1%.
With higher taxes on the horizon, it is more important than ever to have a financial partner who understands the US tax code and how it intersects with your individual situation. In times like these, proactive preparation can be the difference between success and failure. At Monotelo Advisors we have your back, especially when it comes to addressing the lifetime toll that the federal government wants to take on your income.
This content is developed from sources believed to be providing accurate information, and provided by Monotelo Advisors, Inc. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security.