Interestingly, while both the early presidential and vice presidential debates briefly highlighted each side’s approach to tax policy, neither debate nor neither candidate’s statements were entirely accurate.
It seems as if the last four years flew by and here we are again―at the cusp of another presidential election, and perhaps the most contentious one in recent memory. In this Alert, we compare the Trump and Biden tax plans in a quick and easy to digest approach.
Presently, President Trump’s tax plan is to simply secure the Tax Cuts and Jobs Act (TCJA), his landmark legislation passed in December 2017 (and which we wrote about in a previous Alert). Democratic presidential candidate Joe Biden's tax plan is to increase “corporate taxes on day one” and increase individual income taxes on those making over $400,000 annually, as well as increase payroll, income, capital gains and estate taxes.
Interestingly, while both the early presidential and vice presidential debates briefly highlighted each side’s approach to tax policy, neither debate nor neither candidate’s statements were entirely accurate. In sum, Biden’s tax plan will increase taxes for all income groups with the lion’s share of individual income tax changes for higher earners beginning at an income level of $400,000, including an increase in the top income tax rate from 37 percent to 39.6 percent, an additional 12.4 percent Social Security payroll tax on wages above $400,000 and an increase in the capital gains tax rate from 20 percent to up to 39.6 percent for incomes above $1 million while limiting itemized deductions for taxpayers who earn more than $400,000 and have a tax rate higher than 28 percent.
Below, we lay out details of some key points and offer our commentary on the issues.
- For Individuals
There are currently seven tax brackets, ranging from 10 percent to 37 percent. This rate structure was established under the TCJA and is set to expire January 1, 2026.
Maintain the current rate structure under the TCJA and therefore extend TCJA tax rate provisions past 2025. He is also considering a 10 percent middle class tax cut.
Maintain the current seven brackets but modify the top bracket back to the pre-TCJA rate of 39.6 percent. This would largely affect taxpayers with income of $400,000 or more.
In times of potential increases in tax rates, taxpayers should consult with their tax advisers on ways to accelerate the recognition of income. If Biden wins the White House, the Senate flips to a Democratic majority and control of the House remains with Democrats, the likelihood of the top rate reverting back to 39.6 percent is high. Based on a comprehensive analysis of your individual situation, it may be beneficial to accelerate income into 2020 in advance of a rate increase and defer deductions to 2021.
Capital Gains Tax Rates
Under current law, the capital gains tax rate varies based on income with a zero percent rate ($0 to $40,000), a 15 percent rate ($40,001 to $441,450) and a top rate of 20 percent for individuals with income above $441,451 (not including the 3.8 percent net investment income tax).
No change has been announced regarding capital gains treatment, but we can assume that the president wishes to make the TCJA’s current rate and income structure permanent. Additionally, President Trump has expressed interest in indexing capital gains tax rules for inflation adjustments and potentially cutting the maximum capital gains rate to 15 percent.
Eliminate tax preferred capital gains rates for taxpayers with taxable income over $1 million. For taxpayers with income over $1 million, capital gains would be subject to the ordinary income tax rates. This rate would be 39.6 percent, if Biden also were able to increase that rate from 37 percent. Biden's plan would also implement major reforms to opportunity zones.
In a monumental change, Biden would eliminate the tax-preferred treatment that comes from long-term appreciated securities and/or qualified dividends for taxpayers with incomes over $1 million. All long-term gains and qualified dividends for these taxpayers would lose their preferential tax treatment and would be taxed like short-term gains and ordinary dividends both subject to ordinary income tax rates. Based upon your individual scenario and the results of the presidential election, it would be recommended to consult with your financial planner and tax adviser on appropriate planning techniques to avoid losing preferential rate opportunities.
Currently, the United States does not have any tax on accumulated wealth while a taxpayer is living.
Does not support any form of a wealth tax.
While there have been Democratic proposals that would tax unrealized gains, Biden has not endorsed any form of a wealth tax.
While Biden has not endorsed a tax on unrealized gains, some Democratic Senators have provided outlines for a mark-to-market system where unrealized capital gains would be taxed potentially creating liquidity problems. If Democrats win control of the Senate, these proposals could start to be fine-tuned and turned into potential legislation. However, it is our view that many challenges (including constitutional ones) would arise prior to implementation.
Currently, the TCJA is the law of the land when it comes to itemized deductions until 2025, when it will expire. This notably includes:
- The suspension of the Pease limitation on itemized deduction;
- The mortgage interest limitation of acquisition indebtedness of $750,000 (instead of $1 million);
- No interest deduction for home equity loans where the proceeds were not used to buy, build or substantially improve the residence;
- $10,000 cap on the state and local tax deduction;
- Suspension of miscellaneous deductions subject to the 2 percent floor; and
- Charitable contributions limitation increased to 60 percent of AGI (was previously 50 percent of AGI under pre-TCJA).
Maintain TCJA provisions, preventing expiration in 2025.
Proposes implementing a new cap, essentially a restoration of the Pease limitation, on itemized deduction of 28 percent for taxpayers with incomes over $400,000 and ending the SALT cap of $10,000.
Given the potential for a 28 percent limitation on itemized deductions, taxpayers may wish to accelerate their itemized deductions into a tax year where the limitation is not yet implemented. It is prudent to plan for multiyear bunching strategies to prevent coming up short of the total deductions needed to itemize in the current year.
Employment/Social Security Taxes
Currently, wage and self-employment income are subject to a 12.4 percent Social Security tax that is evenly split (6.2 percent) between the employer and the employee in the case of a wageworker and paid 100 percent by a self-employed individual. This tax is on income up to an inflation-adjusted amount, which for 2020 is $137,700.
On August 8, 2020, President Trump issued a memorandum directing the Secretary of the Treasury to defer the withholding, deposit and payment of the employee’s share of Social Security tax (6.2 percent tax withheld from employee wages) paid during the period of September 1, 2020, through December 31, 2020, for workers earning up to $104,000.
Proposes implementing the 12.4 percent Social Security tax on individual earnings over $400,000. This would essentially create a doughnut hole where income between the inflation adjusted amount of $137,700 and below $400,000 would not be subject to the 12.4 percent tax. For wage earners, it is unclear if the amount over $400,000 would be split 6.2 percent by the employee and the employer or if the employee would be responsible for the amount over $400,000 at the full 12.4 percent rate.
With no cap on the 12.4 percent Social Security rate, many high earners will see their marginal tax rates increase as every dollar earned over $400,000 would be subject to the 6.2 percent tax (if employee) or 12.4 percent tax (if self-employed). This means federal taxes would have a marginal rate of over 50 percent after factoring in:
- A renewed 39.6 percent top bracket;
- A 2.4 percent Medicare tax (that already did not have a cap);
- The 0.9 percent additional Medicare tax on wage and self-employment income over $250,000 (if married); and
- The 12.4 percent Social Security tax with no cap on incomes over $400,000.
For taxpayers living in high-tax states like New York, California or New Jersey, they could potentially be faced with a total federal and state marginal tax rate of 60 percent.
However, it is important to note that Social Security taxation cannot be as easily changed via the budget reconciliation process, thus making it less likely to become law no matter who wins the White House and Senate. Unless more legislative procedures change, only a filibuster-proof Senate could change Social Security.
Currently under the TCJA, individuals can claim a $2,000 credit for each qualifying child and a $500 credit for other dependents, with each credit subject to income phaseouts.
Maintain the child credit structure, preventing expiration in 2025.
There has been no insight into the $2,000 child tax credit or the $500 other dependent credit. If he seeks to completely remove the TCJA, then these credits may be reduced to their pre-TCJA amounts. Rather, Biden's plan focuses more on expanding the dependent care credit and to include a higher threshold of qualified expenses from $3,000 for one child to $8,000 for one child or $16,000 for two or more children. The dependent care credit would also allow a 50 percent reimbursement of expenses for income of $125,000 or less and a partial credit for income below $400,000.
More details need to be known about Biden’s stance on the TCJA’s enhanced child tax credit. If the enhanced child tax credit is repealed and the expanded dependent care credit is implemented, it may end up hurting taxpayers. For example, the current dependent care credit is only allowed for children under age 13 while the child tax credit is allowed for children under age 17. The two credits are also not the same in how they are calculated, as they have different income limitations. If passed, taxpayers, particularly those with children age 13 or up and/or taxpayers who do not have dependent care expenses, will want to review their child credit scenario to avoid any unpleasant surprises.
Carried interest is income that flows through to general partners of private equity funds. Under current law, carried interest is taxed at preferential long-term capital gains rates, provided a three-year holding period requirement is met.
Maintains taxation at preferential long-term capital gains rates, provided the three-year holding period is met.
Seeks to tax carried interest at higher ordinary income rates.
Although Biden’s plan does not comment directly with respect to eliminating preferential capital gains rates specifically on carried interest, his proposal to increase the long-term capital gain rate effectively accomplishes this. As a result, private equity sponsors and investors may need to consider revisions to their investment modeling algorithms if Biden wins the White House.
- For Businesses
Corporate Tax Rate
The corporate tax rate is currently 21 percent under the TCJA. The Corporate Alternative Minimum Tax was repealed with the TCJA.
No change as the current tax rate is already permanent and not expected to sunset like other provisions of the TCJA.
Seeks to implement a 28 percent corporate tax rate and add a 15 percent corporate minimum tax on book income in excess of $100 million.
The TCJA made the 21 percent corporate income tax rate permanent from the previous 35 percent rate. Biden’s 28 percent rate seems to be a compromise between the two plans.
Qualified Business Income Deduction (QBID)
To achieve some equality with the 21 percent corporate tax rate, taxpayers other than corporations are allowed a 20 percent qualified business income deduction. This deduction is subject to many limitations/phaseouts and factors in the type of business, the business being either specified service trade or business (SSTB) or a nonspecified service trade or business (non-SSTB).
Currently no planned changes, but President Trump would most likely seek some form of continuation or expanded qualified business income deduction as it is set to expire in 2026.
Keep the QBI deduction but alter the phaseout for those earning more than $400,000. Biden has also stated that he would repeal the “special qualifying rules” for real estate, which may mean a variety of provisions from REIT dividends, safe-harbor rules for rental activities or rental income from related parties.
Considering the complexities of the QBID, any change in the legal structure of the deduction should be met with an immediate consultation with your tax adviser.
Global Intangible Low-Taxed Income (GILTI)
The GILTI is currently at a 10.5 percent tax rate.
Most likely seek some form of extended GILTI tax rate as the provision is set to expire in 2026.
Proposed doubling the rate to 21 percent.
Vice President Biden’s doubling of the GILTI should discourage offshore asset shifting. It is important to note that the GILTI tax is not set as high as Biden’s proposed new 28 percent corporate tax rate.
A 100 percent first-year deduction for the adjusted basis is allowed for qualified property acquired and placed in service after September 27, 2017, and before January 1, 2023, (after September 27, 2017, and before January 1, 2024, for certain property with longer production periods). The additional first-year depreciation deduction is allowed for new and used property.
Extend the business-favorable depreciation deductions. May also seek to allow the 100 percent deduction to continue to past 2023. The deduction is set to phase down from 100 percent to 80 percent, 60 percent, 40 percent and finally 20 percent in 2026.
Repeal the TCJA depreciation provisions that overwhelmingly favor businesses.
If Biden completely repeals the TCJA depreciation provisions, then prior TCJA law (PATH Act) will be in effect. This would result in no bonus depreciation, as bonus depreciation was set to expire in 2020.
1031 Exchanges (aka Like-Kind Exchanges)
Capital gains can be deferred by exchanging property for like-kind property. The basis in the replacement property will be the same basis in the relinquished property in a straight asset-for-asset exchange.
Proposes ending the use of like-kind exchange capital deferral as a means to pay for enhanced child care benefits.
Taxpayers who have significant real estate investments should review their holdings and find assets that they may wish to dispose of within the next eight years. Taking it a step further, you may also wish to find potentially exchangeable like-kind property so you have options available to you in case you need to act immediately if like-kind exchange rules are removed.
- Estates, Gifts and Trusts
Basis of assets passed on to beneficiaries at death is increased to the fair market value of the asset as of the death of the deceased.
Likely to continue with same treatment.
Would eliminate the basis step-up rule and capital gains would be subject to tax at death.
Use of spousal lifetime access trusts can help reduce the impact of the elimination of basis step-up. Funding of a private foundation with stocks with lower basis could also help (more important if Biden is elected, in which case consider transferring wealth sooner rather than later).
Estate, Gift and Generation-Skipping Tax Exemption
Exemption currently sits at $11.58 million via TCJA.
Maintain the changes implemented by TCJA.
Reduce the estate and GST exemption to $3.5 million and gift tax exemption to $1 million.
Consider gifting appreciated assets to a trust or individual prior to death, so as to avoid the tax at death. If the exemption is used this year, no clawback will be permitted if lowered post election, so it would be prudent to use the exemption this year in this potential "use it or lose it" environment.
Currently taxed on a graduated rate basis from 18 percent on estate values up to $10,000 to a maximum of 40 percent plus $345,800 for estates over $1 million.
Maintain current law.
Impose top tax at rates on taxable estates ranging between 40 percent and 80 percent.
If a new administration is elected, accelerate plans to transfer assets.
As we enter the home stretch of the 2020 election season, the outcome and the resulting changes in future tax legislation remain unclear. Typically, clarity occurs on November 3 or 4. This year, however, the outcome of the election and tax policy may not be known until as late as mid-December depending on mail-in ballot voting and disruption, making tax planning for 2020, 2021 and beyond slightly more challenging at this moment. The traditional strategies of deferring taxable income and accelerating deductible expenses may or may not apply, but suffice it to say, tax planning will become increasingly important and complex. The results of the November election will spark questions and may inspire you to modify your tax planning strategies or make you realize you need expert assistance. Perhaps you may be motivated to explore an idea you’ve wanted to implement for far too long. If so, please feel free to connect with us. The Tax Accounting Group can offer insights and recommendations to help clients create a tax-minimizing strategy crafted to their unique needs and goals.