Potential Tax Law Changes Under the Biden Administration
Now that the Democrats have control of the White House and both houses of Congress, many of our clients have inquired about proposed tax law changes and when they might take effect.
Given the Biden administration’s other priorities, many related to COVID-19, we believe it is unlikely that any tax law changes would be applied retroactively to the beginning of 2021. With that said, there is a precedent of Congress making mid-year changes retroactively applicable. Further, it remains possible that certain tax proposals could be enacted more quickly than others. For that reason, it is imperative that our clients prepare for these modifications despite the uncertainty.
The President has proposed many changes to income (individual and corporate) and transfer (estate and gift) taxes. Biden has expressed general support for the repeal of the Tax Cuts and Jobs Act of 2017 (TCJA), but he hasn’t specified exactly what he means by this support. For purposes of this discussion, we will take a look at the Democratic proposals that, if implemented, are most likely to have an adverse impact on our clients.
Proposed Income Tax Changes
- Increase ordinary income rates from 37% to 39.6% for taxpayers with income over $400,000. It remains unclear whether the $400,000 threshold would apply to single filers or joint filers, or both.
- Removal of preferential rates for qualified dividends and long-term capital gains (LTCGs) for taxpayers with incomes over $1 million. Biden has proposed subjecting both qualified dividends and LTCGs to ordinary income tax rates if the taxpayer’s income exceeds $1 million. The net investment income tax of 3.8% would still apply, so the top federal rate for taxpayers could be as high as 43.4%.
- Cap the benefit of itemized deductions at 28%. Placing a 28% ceiling on the benefit of itemized deductions, such as mortgage interest, charitable contributions and state and local taxes currently capped at $10,000, would increase the effective tax rate for certain high-income taxpayers.
- Expand FICA (Social Security) tax to earnings in excess of $400,000. This modification would impose a 12.4% tax on Social Security wages and self-employment income on wages exceeding $400,000.
- Elimination of 1031 Exchanges. It is possible to see elimination of favorable tax treatments related to real estate, such as 1031 exchanges, for taxpayers earning above $400,000.
- Increase corporate income tax rate from 21% to 28%. It is likely that the corporate income tax rate could be increased to 28%, and perhaps as high as 35% if the TCJA is repealed.
Proposed Transfer Tax Changes
- Decrease the current gift, estate and generation skipping transfer (GST) tax exemption. A repeal of the transfer tax provisions of the TCJA would reduce the current transfer tax exemption of $11.7 million back to $5 million (as adjusted for inflation). The Democratic Presidential platform calls for reduction of the exemption even further to $3.5 million, which is the amount previously proposed back during the Obama/Biden administration. Regardless, even without any policy enacted, the current exemption amount is to revert back to $5 million (as adjusted for inflation) on January 1, 2026. Many clients used all or a large portion of their exemption at the end of 2020 to lock in the high exemption amount. For those who still have their unused $11.7 million exemption, we suggest full consideration to making gifts in 2021 in anticipation of a proposal to reduce the exemption in the offing.
- Increase the transfer tax rate from 40% to 45%. The current 40% rate would not be impacted by a repeal of the TCJA but some commentators believe that there may be a transfer tax rate increase to 45% under the Democratic platform.
- Elimination of the step-up in tax basis at death. Currently, assets in a decedent’s estate receive an income tax basis step-up to the fair market value on date of death. Elimination of the step-up in basis could have a serious tax impact on clients who hold highly appreciated assets or received such assets as an inheritance. It remains unclear whether any changes would be limited to a carryover basis for inheritors or an income tax would be imposed on the appreciation at death.
- Restrictions on valuation discounts. Regulations were proposed during the Obama/Biden administration that would restrict fair market value discounts when there is a transfer of assets that are subject to lack of control or marketability. These regulations were withdrawn in 2017 but there remains the possibility that a version of such regulations could be reintroduced under the Biden administration or proposed as a law change. We can help structure and implement wealth transfer strategies that would enable you to take advantage of a valuation discount while still available.
As you can see there are numerous tax proposals that could impact your income and estate tax planning. It is vital that you remain in communications with your trusted advisors to help you navigate through new tax policies under the Biden administration. We will certainly do our best to keep our clients apprised as tax proposals and policies are announced. Until then, please don’t hesitate to contact a Lex Nova Law attorney to discuss