There is a lot of confusion about President-elect Joe Biden’s tax proposals. And with the state of the economy and a nearly split Senate, it’s hard to say what tax changes could actually be passed in 2021.
Today, I’m going to highlight some of Biden’s tax proposals and what they could mean for your retirement. Biden's major tax proposals include changes in individual income taxes, estate and gift taxes, corporate taxes, and Social Security taxes. Most of the proposals result in higher taxes for high earners.
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Tax Cut and Jobs Act
The current historically low tax rates under the Tax Cut and Jobs Act of 2017 are scheduled to retire after 2025. This is one of the reasons why I have been a big proponent of Roth conversions. We want to smooth out your lifetime tax liability with those low rates that we know we have right now.
However, under a Biden presidency, tax laws could change between 2021 and 2025. Biden has said he wants to repeal the Tax Cut and Jobs Act (TCJA) while keeping the tax cuts for households earning less than $400,000.
Biden has also proposed to tax all capital gains at the higher ordinary income tax rates for those earning over $1 million per year. Currently, only short-term capital gains are taxed at ordinary income tax rates.
Long term gains are currently taxed at 0%, 15%, or 20%, based on your income, while ordinary income tax rates range from 10% to 37% based on income.
Estate Taxes & Inherited Assets
The current federal exemption for estate taxes is $11.18 million. It is expected that Biden would reduce that to somewhere in the range of $3.5 and $6 million.
Biden has also proposed to eliminate the step-up basis on inherited assets at death and the death would become a “taxable event.” This means the appreciated assets would be treated as sold at the death of the owner, and the estate would have to pay the taxes based on the original purchase price.
Under current law, the step-up basis would increase the beneficiary’s cost basis in the inherited asset to the value at the death of the owner to minimize the beneficiary’s capital gains taxes. Currently, any capital gains tax paid in the future would be based on the stepped-up basis rather than the original purchase price.
This could have some estate planning implications for higher-income households going forward.
Currently, Social Security taxes are withheld from individual wages up to $137,700. Under Biden’s plan, Social Security taxes would be reinstated for wages above $400,000, leaving a gap in wages subject to Social Security taxes between 137,700 and $400,000.
Other Potential Changes
- Itemized deductions will be reduced for those earning more than $400,000, and itemized deductions will be capped at 28% of income.
- The qualified business income deduction will be eliminated for those earning over $400,000.
- The current corporate tax rate of 21% would be increased to the pre-TCJA rate of 28%.
- Retirement contributions to 401(k) plans would be given a tax credit rather than a reduction in taxable income. This means retirement contributions would no longer reduce adjusted gross income and certain phase-out brackets would be reached faster.
New Potential Credits
- Child and dependent credits and childcare credits would be increased, and an elderly care credit would be added.
- First-time homebuyers could receive an advanced credit of $15,000 that can be used toward a down payment.
- Renters could receive a credit to bring the cost of rent down to 30% of income.
- A residential energy credit could be restored as well as adding an electric car credit.
These are merely proposals at the moment and basically a high-level view with few details, but we will keep an eye on them and will certainly be prepared if we need to make changes to retirement plans. As with any proposal, these changes would need to pass through Congress before they become law.
We build retirement plans that are flexible and determined by actual facts and current laws rather than rolling the dice on the future. We don’t change our investment strategy based on who is president. The stock market doesn’t care who is president. The top companies in the world will continue to succeed regardless of who is president.