How Tax Proposals and the American Families Plan May Impact High-Income and High-Net-Worth Taxpayers
President Biden’s tax proposals during his campaign included significant changes directly aimed at individuals and families with higher incomes and wealth. Several of these proposals have made it into the fact sheet for the American Families Plan that Biden presented in his first address to a joint session of Congress on April 28.
Biden’s American Families Plan promises to “deliver a fairer and more equitable America”’ by making investments to provide for universal pre-school for all 3- and 4-year-olds, free community college and other postsecondary investments, education and preparation for teachers, affordable high-quality child care, paid family and medical leave, and nutrition. He also proposes many tax cuts for American families and workers, including extending some tax cuts and permanently increasing some tax credits aimed at lower income families, as well as giving the IRS the authority to regulate paid tax preparers.
All of this is meant to “reward work – not wealth.” Biden’s tax agenda is structured to ensure that “high-income Americans pay the tax they owe” and uses these new revenues to pay for his investments.
Below, we highlight some of the president’s more significant tax policy changes affecting high-income and high-net-worth taxpayers:
|Tax Policy Issue||Current Law||Biden Campaign Proposals||Included in American Families Plan Fact Sheet|
|Tax rate on ordinary income||Top marginal rate is 37% until 2026 (if current law expires, top marginal rate reverts to 39.6% beginning in 2026).||Restore top marginal rate to 39.6% for taxpayers with over $400,000 of taxable income (it’s not clear as to how this relates to filing status).||Restore top marginal rate to 39.6% for taxpayers with over $400,000 of taxable income (it’s still not clear as to how this relates to filing status).|
|Tax rate on long-term capital gains & qualified dividends||0% (income between $0 and $40,000) 15% (income between $40,001 and $441,450) 20% (income above $441,450)||Tax capital gains and qualified dividends at 39.6% for taxpayers with over $1 million of taxable income (and potentially for all taxpayers). With the net investment income tax added, this results in a 43.4% federal tax rate.||Tax capital gains and qualified dividends at 39.6% for “households” with over $1 million of taxable income (and potentially for all taxpayers). With the net investment income tax added, this results in a 43.4% federal tax rate.|
|Tax rate on carried interests||If held at least 3 years, taxed at long-term capital gain rates.||Taxed as ordinary income||Taxed as ordinary income|
|Itemized deduction cap||Itemized deduction limit repealed (the current law expires in 2026)||Cap value of itemized deduction at 28% (rather than the then top 39.6%).||Not addressed|
|3% Pease limitation on itemized deductions||No current limitation (the current law expires in 2026).||Reinstate the Pease limitation for those with income above $400,000.||Not addressed|
|High-income Social Security payroll tax||No Social Security payroll tax on income above $137,700 in 2020 (indexed).||Impose the 12.4% (6.2% for the employer and 6.2% for the employee) Social Security payroll tax on income in excess of $400,000.||Not addressed|
|Pass-through trade/business income (§ 199A)||20% deduction||Implement a new phaseout for income over $400,000||Not addressed|
|§1031 like-kind exchange||Available for real property used in trade or business, or held for investment||Eliminate §1031 for taxpayers with over $400,000 income||Limit §1031 exchanges to $500,000 of gain|
|Estate and gift tax exclusion||Basic exclusion is $11.58 million in 2020 (continued indexing); expires at the end of 2025.||Return the exclusion back to 2009 levels of $3.5 million for estate and $1 million for gifts (maybe it ends up at $5 million).||Not addressed|
|Estate and gift tax rate||40% rate estate, gift and generation-skipping tax||Return the tax rate back to 2009 levels (45% rate).||Not addressed|
|Estate basis step-up at death||Beneficiaries receive a step-up in basis at death.||Repeal stepped-up basis at death.||Repeal stepped-up basis at death in favor of forced recognition of gains in excess of $1 million per taxpayer if not donated to charity and include protections for certain family-owned businesses and farms.|
Although the inclusion of these items in the fact sheet is an indicator, there was a clear lack of details and effective dates. We expect additional technical details to be released as discussions continue in Congress that could impact the details of the final legislation.
Below are a few strategies that are worth consideration.
Ordinary income – With income over $400,000 moving from the 35% and/or 37% marginal brackets to a 39.6% marginal tax rate, consider accelerating income that would fall into those lower brackets and deferring deductions that could provide a more valuable shelter for income at a higher rate in future years. This could include items like bonuses, exercising options (maybe), and liquidation of investments with passive losses as well as deferring business expenses when it makes sense.
Long-term capital gains and dividends – The potential increase from the base tax of 20% to 39.6% on long-term capital gains and qualified dividends is a significant and fundamental shift that practically doubles the tax on this category of income for taxpayers with over $1,000,000 in taxable income. If you expect to fall into this category in future years, you may want to consider accelerating capital gains to take advantage of lower tax rates on gains this year.
Also, it may make sense to defer recognizing losses to future years to allow for the offset of future capital gains at the higher tax rate. These strategies must be reviewed carefully to ensure the lower tax rate paid now offsets the benefit of tax deferral at a higher future rate. Gifting of appreciated securities to lower-income individuals becomes even more attractive now, as they will incur half the tax liability upon sale.
For those that may have taxable incomes that are not consistently above $1,000,000, it will be crucial to take advantage of any potential “smoothing” of income year to year where possible. Ideally, recognizing enough gain to get you to just under that threshold will save significant capital gains taxes. Executing installment sales to spread gain over more than one year on eligible property may be a great option.
Itemized deductions – The general advice for taxpayers was to accelerate deductions and defer income, but the new advice is to time your deductions based on your individual year-to-year circumstances. The higher your income, the more the Pease limitation, if reinstated, affects your ability to benefit from itemized deductions in future years, so careful consideration and projections for the next few years can be extremely valuable. Your advisor may suggest bunching your deductions to minimize the impact of the Pease limitation, which reduces the value of itemized deductions by 3% for every dollar of taxable income above a certain threshold, with the phase-out capped at 80% of the total value of itemized deductions.
- Charitable contributions – You may consider front-loading charitable contributions to maximize their cumulative impact by avoiding additional limits and phase-outs on itemized deductions with the potential law change. Plan with your tax advisor to maximize the benefit of current year charitable contributions. Remember that in certain circumstances, it may be advisable to defer them to capture a larger benefit under higher tax rate brackets going forward.
- Real estate taxes – If the $10,000 current deduction is providing benefit in 2021, defer only the balance of real property taxes in case the $10,000 state and local tax (SALT) deduction cap is repealed.
- State estimated income tax payments – Consider the benefit of deferring 2021 estimated tax payments to January of 2022 against potential penalties for late payment if the SALT cap is repealed.
Retirement – A lot of people focus on pre-tax savings for retirement, but there are other considerations as well. With rates potentially rising in the near future, now is a great time to study moves that could take advantage of the current lower rates. Here are a few strategies to review:
- Individuals with net unrealized appreciation (NUA) in an employer’s plan should look to see if it makes sense to take the NUA out prior to rate increases.
- Consider conversion of part of your IRA to a Roth IRA before the rates increase. You should run some scenarios with an advisor to see how much might make sense, as it may not be advisable to allow a conversion to push you into the next higher bracket. Also consider the potential state tax liability that this could create.
- If you are eligible for an HSA, remember that this has the benefits of both a Roth IRA and a traditional IRA in one if its use is planned and executed properly.
Estate tax – Between the Tax Cuts and Jobs Act (TCJA) sunset provisions and the current political environment, some taxpayers are struggling with using the exemption before it is significantly reduced and giving up both access and control of that same property. Depending on your overall net worth and personal situation, there are several options that could be explored to ensure that you don’t lose the historically large estate tax exemption, which is slated to revert back to $5 million in 2026 or could go even lower before then based on proposals by President Biden, Senator Sanders and Senator Van Hollen.
In addition to the reduction in the lifetime exclusion, Biden has also proposed eliminating the basis “step-up” to fair market value at death, which allows for a deferral of gain until the beneficiaries ultimately sell an asset. This will completely change the approach to estate planning and wealth transfer, and a careful review of your current plan could result in a great deal of tax savings over your lifetime.
Our Recommendation: Start Planning Yesterday
Don’t wait to formulate your plan, as you need time to analyze scenarios and options with your advisors in advance. Although these are currently just proposals, with the potential for some of this to be enacted quickly or even retroactively, now is the time to be proactive in planning for income taxes, as well as transferring wealth.
For questions or assistance, contact our experts.