Smart Tax Planning

These households can expect a tax increase under Biden’s tax plan

Key Points
  • The Democratic presidential candidate has proposed tax increases on individuals with taxable income exceeding $400,000. The top individual income tax rate would be increased to 39.6% from 37% under his plan.
  • Payroll taxes will also rise for high earners. Biden calls for the 12.4% portion of the Social Security tax to apply to earnings over $400,000.
  • In order to make this happen, Democrats have to take the White House, maintain a majority in the House and grab the Senate.
Democratic presidential nominee and former vice president Joe Biden speaks at a campaign stop in Miami on Oct. 5, 2020.
Roberto Schmidt | AFP | Getty Images

Taxes could rise for the wealthiest households  in a Joe Biden presidency.

However, you might want to think twice before making any dramatic moves.

Indeed, Biden's tax plan was a topic of discussion during the debate between vice president Mike Pence and Sen. Kamala Harris, D-Calif., on Wednesday night.

The two clashed over the effectiveness of the Tax Cuts and Jobs Act — President Trump's tax overhaul that went into effect in 2018 — and the plan Biden has drafted.

During the debate, Pence asserted that President Trump has cut taxes across the board. Though indeed the Tax Cuts and Jobs Act roughly doubled the standard deduction and reduced individual income tax rates, those provisions will end after 2025.

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The law also doubled the estate and gift tax exemption to more than $11 million from 2018 through 2025.

Meanwhile, Biden's  plans calls for tax increases on households with taxable income exceeding $400,000.

Those taxpayers could see their individual income taxes tick up under a Biden presidency, as he has called for boosting the top individual income tax rate to 39.6% from its current level of 37%.

The Democratic candidate has also called for increasing levies on wealth transfers.

Don't bet on these changes happening immediately.

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That's because even if Biden wins the White House, Democrats will need to maintain their majority in the House and take the Senate for these proposals to move forward.

"Do you really think that when someone runs on an idea, gets elected and has control of Congress that that program is a sure thing?" said Ed Zollars, CPA and partner at Thomas Zollars & Lynch in Phoenix and an instructor at Kaplan Financial Education.

He recalled how "repeal and replace" became a rallying cry for the GOP in 2016 as politicians pushed to overturn the Affordable Care Act. Four years later, the health-care law is still here.

"Don't get ahead of yourself," Zollars said.

Income tax increases at the high-end

Vice President Mike Pence and Sen. Kamala Harris, D-Calif., took part in the vice presidential debate at the University of Utah  in Salt Lake City on Oct. 7, 2020.
Eric Baradat and Robyn Beck | AFP | Getty Images

On the income tax side, Biden calls for raising the top individual rate to 39.6% from 37%, and applying it to taxpayers with taxable income over $400,000, according to an analysis from the Tax Policy Center.

He's also talking about an increase to payroll taxes for those high-earners. Biden would extend the 12.4% portion of the Social Security tax — which is shared by both the employee and employer — to earnings over $400,000, the Tax Policy Center found.

Currently, the Social Security tax is subject to a wage cap of $137,700 and is adjusted annually.

Finally, Biden would also boost rates on long-term capital gains and qualified dividends to 39.6% — the same top rate as ordinary income — for those with income over $1 million, according to the Tax Foundation.

Currently, the long-term capital gains tax rate is 20% for single households with more than $441,451 in taxable income ($496,601 for married-filing-jointly) in 2020.

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The tax  applies when you sell investments you've held for at least a year.

So rushing to sell appreciated investments, as well as converting traditional Individual Retirement Accounts to a Roth and paying the income tax at a lower rate now, may seem like a good idea if you think taxes are going to rise later.

Talk to your tax professional about your own circumstances before you act. Strategizing is smart. Kneejerk sales and transfers aren't.

"I've had more calls with clients and prospects about reacting to a change in tax policy in the last three weeks than in the last year and a half, so people are starting to anticipate," said Tony Nitti, CPA and partner in RubinBrown's tax services group in Denver.

"That said, I don't think anyone is putting anything into practice right now."

Implications for estates and gifts

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Earlier this summer, Biden collaborated with Sen. Bernie Sanders, I-Vt., and the two formed six task forces to release a 110-page policy document. The paper gives some insight on what we might expect from a Biden administration.

"Estate taxes should also be raised back to the historical norm," the task force wrote in the policy plan.         

The Tax Cuts and Jobs Act roughly doubled the amount that you can transfer to other people — either at death or as a gift during life — without facing the 40% estate and gift tax.

The gift-and-estate tax exemption is $11.58 million per individual in 2020.

Biden has set his sights on the "step-up in basis," a provision in the tax code that allows an individual to hold onto an asset for years, watch it appreciate and then bequeath it to an heir at death.

The owner's basis — the original investment in the asset — steps up to market value at death, which means the heir is subject to little to no capital gains taxes if he sells it.

Biden proposes taxing the unrealized capital gains in the asset at death, which essentially does away with the step-up.

The wealthiest families may look at gifting assets, perhaps to a trust or outright to their children or grandchildren, to use up the exemption while it's still high under the Tax Cuts and Jobs Act.

While you don't want to give away your assets prematurely, it doesn't hurt to start talking to your financial advisor about what you might do next.

"Be prepared, but don't do things you can't undo — things that might turn out to be a disaster if this scenario doesn't work out the way you expect," said Zollars.