If the early indications of a divided Congress bear out, the resulting political gridlock could complicate plans for sweeping tax changes. Here’s how each party's tax policy would affect different segments of the population.
Note, this article is written by Karen Hube with Barron's on November 9, 2020. Information may have changed by the time you read this.
Tax policy took center stage in the final days before the U.S. presidential election. A lot gets accomplished— or partially accomplished, or at least attempted— through the tax code; this year, the two presidential candidates claimed it as a tool to lift the nation out of its deep and lingering economic slump.
Their ideas are, not surprisingly, starkly different: Former Vice President Joe Biden has a detailed plan to raise taxes on corporations and the top 1% of individual earners, and to provide a host of clearly outlined tax breaks to moderate- and lower-income families to ease the financial straits brought on by the pandemic and incentivize spending to help recharge the economy.
In contrast, President Donald Trump argues that any tax increase for the wealthy would be ruinous to the economy. He says that he wants to keep the lower taxes enacted in 2017 in the Tax Cuts and Jobs Act, or TCJA—which expires at the end of 2025—and pass even more tax cuts, but he hasn’t released details.
In any case, if the early indications of a divided Congress bear out, the resulting political gridlock could complicate plans for sweeping tax changes.
Here’s how each candidate’s tax policy would affect different segments of the population.
Biden plans to raise the top marginal individual income-tax rate from 37% to 39.6%, which was the top rate until the TCJA went into effect in 2018. Biden would essentially accelerate the expiration of the 37% rate—which applies to taxable income of more than $518,400 for individuals and $622,050 for married couples. All other brackets would remain at today’s levels: 35%, 32%, 24% 22%, 12%, and 10%. These rates are applied to taxable income, the amount after all deductions have been taken.
Top earners would also get pinched with a new Social Security tax, which, when combined with the Medicare tax, is referred to as the payroll tax. Currently, the 12.4% Social Security tax is applied to up to $137,700 of income. Salaried employees split the tax with their employers, paying 6.2% each. The employees’ share is deducted from their paychecks. Self-employed workers pay the entire amount. Under the Biden plan, the payroll tax would also apply to income over $400,000, creating a donut hole in the policy: Income from $137,700 to $400,000 wouldn’t be subject to the levy.
“All of Biden’s proposals try to avoid a higher tax bill for taxpayers earning less than $400,000. ”
— Garrett Watson, Tax Foundation
Biden would also trim deductions for people with income of more than $400,000 in several ways.
His plan imposes a 28% cap on the value of itemized deductions. So, in the top tax bracket, every deductible dollar would be reduced by 28%, instead of 39.6%.
It also reinstates a phase-out of deductions referred to as the Pease Limitation for top earners, which effectively reduces deductions on every dollar by three cents.
Finally, owners of pass-through entities such as S corporations or partnerships with income of more than $400,000 would lose a 20% deduction enacted under the TCJA.
Trump’s plan for top earners is to extend the provisions under the TCJA beyond their scheduled expiration, maintaining the top tax rate at 37% and the 20% deduction for pass-through owners.
According to an analysis by The Tax Foundation, under Biden’s plan the nation’s top 1% of earners would see their annual after-tax income decrease by 11.3%; the next 4% of top earners would see after-tax income drop by 1.3%. Under Trump, by leaving the TCJA as is, the top 20% of earners would see a 2.4% increase in after-tax income.
Biden released his initial tax plan in April, but has updated it to address the financial hardships related to this year’s economic contraction. He proposes a long list of new or enhanced tax credits. Among them:
- A temporary increase (which would expire after the economy recovers) in the child tax credit from a nonrefundable $2,000 per child up to age 16 to a refundable $3,600 per kid up to age 6 and $3,000 for kids up to age 17. A refundable credit is paid as a refund, even if the person doesn’t owe taxes.
- An increase in the value of the child and dependent care tax credit from a maximum nonrefundable $2,100 for two or more children, to a maximum refundable $8,000.
- A $5,000 credit for informal caregivers.
- A $15,000 credit for first-time home buyers, and a credit to ensure that rent and utility bills don’t exceed 30% of monthly income.
- Expanding eligibility of the Earned Income Tax Credit to childless workers over age 65. Currently, the credit isn’t available to these taxpayers.
There is no intentional tax increase for folks earning less than $400,000 in Biden’s plan, but it is still a work in progress, says Garrett Watson, senior policy analyst at The Tax Foundation, a nonpartisan think tank. “All of Biden’s proposals try to avoid a higher tax bill for taxpayers earning less than $400,000,” Watson observes. “If there are places where they result in a higher tax bill, they’ve said they’ll fix that.”
As for Trump, he plans to extend the current law and has said he wants to cut taxes on the middle class, but hasn’t disclosed specifics. He has also vowed to push through permanent cuts to the payroll tax, which is used to fund Social Security and Medicare.
In August, the president issued an executive memorandum to allow employers to defer payroll taxes for anyone earning less than $4,000 biweekly for the rest of 2020. However, few companies and employers are taking advantage of the temporary measure, citing administrative complications.
According to the Tax Foundation’s analysis, Biden’s plan would increase after-tax income for the bottom 20% of earners by 10.8% through 2025; the next quintile would see a 3.6% bump.
Under the TCJA, the bottom 20% of earners are likely to see less than a 1% increase in after-tax income, and the next quintile, an increase of 1% to 1.5%.
Under Biden’s plan, investment profits that exceed $1 million would be taxed at regular income-tax rates of up to 39.6%, rather than the current highest capital-gains tax rate of 20%. For gains below $1 million, the current long-term rate—for investments held for more than one year—would still apply.
Biden’s plan keeps the capital-gains tax rate the same for the bottom 99% of earners: Married couples who have taxable income of less than $80,000 won’t owe any capital-gains tax; when taxable income is more than $80,000 but less than $496,600, a 15% tax applies to gains. Couples with income between $496,600 and $1 million would pay a 20% tax.
Trump says that he wants to cut capital-gains taxes. While he hasn’t issued any details, capital-gains tax cuts generally disproportionately favor wealthier folks, because they are far more likely to have money in regular, taxable brokerage accounts, and more money in them. Money held in individual retirement accounts, 401(k)s, and other tax-deferred plans are never subject to capital-gains taxes; investors generally don’t pay income tax on the contributions, gains grow tax-free, and money withdrawn is taxed at ordinary income-tax rates.
Benefactors and Heirs
Most of Biden’s plan is aimed at taxing the wealthy more, and reducing taxes for people earning less than $400,000 a year and who don’t regularly incur millions in capital gains. Much of his proposal is based on repealing the TCJA, and working from there. The same is true of his approach to the estate tax, but his approach to how assets are passed on after death is perhaps the most controversial, and least detailed, part of his plan.
The TCJA doubled the $5.49 million per person estate-tax exemption and adjusted it for inflation; now, any individual can leave an estate up to $11.58 million without incurring the estate tax. The figure is $23.16 million per couple. Biden plans to return the exemption to its 2009 level of $3.5 million per person, and raise the estate tax rate to 45% from 40%.
Estate tax is paid by the estate itself, before the assets are divvied up and given to the heirs. Typically, heirs don’t owe any tax on property they inherit, even if they sell it right away.
Here’s where things get a little surprising, and light on specifics: Biden’s plan would also eliminate the step-up in cost basis at death. Under current law, the cost basis, or purchase price, of assets is reset to the current market value at the owner’s death. Heirs may inherit an asset with massive embedded capital gains, but that capital-gains clock is reset to zero on the date of death, and tax is owed only on appreciation after that. For instance, if you inherit the home your parents bought for $50,000 and, at their death, was worth $800,000, your cost basis would be “stepped up” to $800,000. If you sold it right away, you would not owe any tax.
Biden’s plan changes that and raises a host of concerns and confusion. “Some in the industry are calling this a stealth estate tax, or a double tax,” says Ali Hutchinson, managing director at Brown Brothers Harriman. That’s because the levy is assessed based on the estate’s fair market value. Example: An estate of $6 million would owe estate tax on about $500,000—the $6 million minus the proposed $5.49 million exemption—before it is distributed to the heirs. They would inherit the property with the original cost basis, so, whenever they sold, they’d owe capital-gains tax on the profit off the original purchase price. In other words, the same assets would be taxed twice.
It is unclear in the language of Biden’s plan if capital-gains taxes would be owed upon death of their owner, regardless of whether the assets were sold, or if the taxes would be triggered when heirs sell the assets.
“This change would be a very big deal. It would change the way people manage portfolios,” Hutchinson says. “We have people going through crazy contortions to not realize gains toward the end of their lives—hedging strategies, borrowing. This could turn planning on its head.”
Clay Stevens, director of strategic planning at Aspiriant, doubts that the step-up will be eliminated. “They tried to get rid of it in the early 1980s, but realized it was an administrative nightmare,” he says. For taxpayers, finding the cost basis for all inherited assets is one problem. And for the Internal Revenue Service, “the assumption is the cost basis is zero, unless it can be proved otherwise.”
Typically, tax laws take effect in the calendar year after they are passed, so, it’s possible that new rules could be enacted in 2022—though there certainly will be some adjustments made from here.
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