Regardless of who wins the election, there is potentially a lot of financial planning throughout this coming election cycle. Here is a summary of some of the tax changes that are to be expected from each candidate. A special eye to keep on the consideration to remove the set-up in basis on inherited property.
Today's guest post is brought by Karen Hube
Aug. 14, 2020
Politicians—both local and national—have long used the tax code to “fix” or change the economy, markets, and investor or consumer behavior. This presidential election year will be no different, as President Donald Trump and former Vice President Joe Biden try to convince voters that each is better equipped to lift the nation out of one of the worst downturns in history.
“You can’t underestimate the finesse that’s going to be needed to raise revenue, but first to get the economy jump-started,” says Kate Barton, global vice chair of tax at Ernst & Young. “It’s inevitable the tax code will get used to do this, whoever wins the election.”
Both candidates’ plans are early drafts, and neither fully addresses the nation’s deep pandemic-fueled fiscal challenges. Both almost certainly will be revised, but “don’t underestimate rhetoric before the election,” Barton says. “It was amazing to see how quickly reform got done under [Trump], and it’s likely to happen again, no matter who is elected.”
Trump’s plan thus far is limited to endorsing the idea of payroll-tax reductions, tweets about a potential capital-gains tax cut, and vowing to extend the Tax Cuts & Jobs Act, or TCJA, which went into effect in 2018 and is set to expire at the end of 2025. Overall, his message is one of easing taxes, mostly on the wealthy; the TCJA disproportionately benefits wealthy folks and businesses.
Biden’s plan lays out specifics; it focuses on eliminating the benefits offered by the TCJA, and includes additional measures to raise federal revenue. While his proposals aren’t as extreme as those of Sens. Elizabeth Warren or Bernie Sanders, they are significant. Compared with Hillary Clinton’s proposals in 2016, Biden’s would raise three times the tax revenue—$3 trillion versus $1 trillion.
Biden would focus on the top 1% of earners, those making more than $400,000 a year. He would raise taxes on ordinary income above $400,000 by returning the top marginal rate to 39.6%—where it was before the TCJA lowered it to 37%. Other tax rates would stay the same.
“Four hundred thousand dollars in income lies roughly at the 99th percentile, which may partly explain why the Biden campaign chose that income level, though I haven’t seen an official explanation,” says Garrett Watson, senior policy analyst at the Tax Foundation.
In an effort to shore up the Social Security system, Biden has proposed subjecting income above $400,000 to the 12.4% Social Security tax, also known as a payroll tax. For salaried workers, the tax is split 50/50 with employers; they pay 6.2% themselves and deduct the other 6.2% from paychecks. Self-employed workers pay the entire 12.4%.
“Biden’s tax plan would slow economic growth because of the way [it] raises revenue. ”
— Garrett Watson, Tax Foundation
Currently, the tax is applied only to income up to $137,000; earnings above that aren’t subject to payroll tax.
This provision would create a doughnut hole in Social Security tax policy—income below $137,000 and above $400,000 would be subject to the payroll tax, but not income between those levels.
Biden also proposes to change the long-term capital gains tax rate on investment income exceeding $1 million. Stocks, bonds, funds, and other investments that are owned for more than a year get special tax treatment when they’re sold: The gains, or profits, aren’t taxed for married couples with total income below $80,000; they’re taxed at 15% if the couple’s income is above that, but below $496,600. For those with income above that, capital gains are taxed at 20%. Biden adds an additional tax for investment gains that exceed $1 million, regardless of your total income: Any profits that exceed $1 million would be taxed at the ordinary income rate of 39.6%.
Deductions for top earners would be limited under Biden’s plan. Currently, only 10% of taxpayers itemize deductions. But more than half of the top 10% of earners are among them, according to the Committee for a Responsible Federal Budget, or CRFB, a nonpartisan nonprofit group in Washington, D.C.
The TCJA sharply shrank the number of itemizers. The law enacted a $10,000 cap on state and local income and property tax deductions, while raising the standard deduction for a couple to $24,800. Generally, only wealthier people have enough deductions to make itemizing worthwhile.
For folks earning more than $400,000, Biden would impose a 28% cap on the value of itemized deductions. This essentially reinstates the “Pease limitation,” which the TCJA scrapped. Its proposed reinstatement means that a taxpayer in the highest bracket would get a 28%—rather than 39.6%—reduction for every deductible dollar, according to the CRFB.
Keeping with Biden’s focus on the wealthiest, estate tax and wealth-transfer breaks are also in his crosshairs. The TCJA doubled the amount that an individual could pass on to heirs without being taxed. The estate tax exemption is now $11.58 million; Biden proposes returning the exemption to its 2017 level of $5.49 million, adjusted for inflation.
“Trump[’s] impulse to cut taxes no matter what is also not a good way to address the crisis. ”
— Garrett Watson, Tax Foundation
Perhaps the most aggressive aspect of Biden’s plan scraps the step-up in cost basis on inherited investments. Currently, when heirs inherit something that has appreciated in value—such as an investment portfolio, or a house—they get a “step-up” in basis, meaning they inherit the asset at its current market value. This minimizes or even eliminates the capital gains tax if they decide to sell right away, or gives them a fresh start on future gains if they hold on to the property.
Biden’s plan includes a few expanded benefits to taxpayers. The biggest are the reinstatement of a homebuyers’ tax credit that was in effect for two years after the 2008-09 recession, a new low-income renters’ credit, and expansion of the child and dependent care tax credit.
As for businesses, Biden would raise the corporate tax rate from 21% to 28% and enact a 15% minimum “book tax”—a levy on income, net of expenses, for corporations with an income of $100 million or more.
The corporate tax was lowered from 35% to its current rate in 2018 under the TCJA. In tandem, pass-through entities—which represent most small and medium-sized businesses and are subject to ordinary income tax rates—were given a potential 20% deduction. Biden proposes to get rid of the 20% deduction for pass-through income exceeding $400,000.
Comparing the candidates’ plans is problematic, given that Trump has not actually issued a plan beyond a desire to make the Tax Cuts and Jobs Act permanent. His lack of detail also makes economic impact estimates difficult. Assuming that the president extends the TCJA but does nothing else, the Tax Foundation figures that after-tax income for individuals would increase an average of 1.5%. The top quintile of earners would see the highest average gain: 2.4%.
Extending the TCJA would boost long-term economic growth by 2.2% and wages by 0.9%, and add 1.5 million full-time jobs. At the same time, it would decrease federal revenues through 2028 by more than $600 billion, according to the Tax Foundation.
Under Biden’s plan, the top 1% of earners would bear the biggest brunt, with a 7.8% decrease in after-tax income, followed by the top 5% with a 1.1% hit, according to the Tax Foundation. Other individuals would see an average 0.6% reduction in after-tax income.
Biden’s plan would reduce economic growth by 1.51%, but increase tax revenue by $3.8 trillion over the next 10 years—about half due to tax changes for businesses, according to the Tax Foundation.
“Biden’s tax plan would slow economic growth because of the way the plan raises revenue—for example, the increase in the corporate income tax rate and the minimum book tax raises the cost of making new investments on the margin, which tends to reduce long-run economic growth,” Watson says. “The challenge is finding ways to raise revenue that minimize the impact on economic growth, as some forms of taxation (land taxes being a well-known example) have less of an effect on economic growth.”
Neither plan effectively addresses the economic distress from the pandemic, Watson observes. “The coronavirus has thrown a wrench into both of the plans,” he says. “On Biden’s side, raising taxes on earners across the income spectrum in a downturn—he may have to change that. And under Trump, the impulse to cut taxes no matter what is also not a good way to address the crises.”
Economic stimulus is sorely needed, but so is an increase in federal revenue, Watson says.
Both plans are likely to evolve—in part because sweeping, but unrealistic, changes are often promised during campaigning, and because tax policy is not entirely at the president’s discretion. Ultimately, what gets enacted rests on Congress: Neither Biden nor Trump will be able to push any dramatic changes through both houses of Congress if their parties don’t hold a majority, says Steve Aucamp, managing director at Tiedemann Advisors.
Among Biden’s proposals, those with the highest probability of becoming law are the bump-up in the highest individual income tax rate to 39.6% and the rollback of the estate tax exemptions, because both will occur anyway if the TCJA expires in 2025, as scheduled, says Bill Smith, managing director of the national tax office of advisory company CBIZ MHM in Washington, D.C. “Those could be middle ground for both parties to agree on,” he notes.
In contrast, the former vice president’s proposal to eliminate the step-up in the cost basis of inherited assets is likely to raise heated objections, possibly in both parties.
“That’s a huge philosophical shift that minimizes the significance of family-owned business in America,” says Ric Edelman, founder of Edelman Financial Engines. “Historically, the step-up existed on the premise that wealth was embedded in small-business market value and farms. Without the step-up, when the farmer or business owner died, the children would have to sell to pay the tax.”
While Biden’s tax proposal is more progressive than Trump’s—meaning it places more of the burden on wealthy taxpayers—it is not progressive in a historical sense, considering that the top income-tax rate 40 years ago was 70%, Edelman says, and 50% throughout most of the 1980s.
“Biden is contemplating returning the top tax rate to 39.6%, not 70%, so he is maintaining the concept of a flatter tax structure,” Edelman says. “That perpetuates the Republican movement that began with Ronald Reagan toward a flatter tax.”
On business taxes, Ernst & Young’s Barton points out, there are more similarities than differences in the candidates’ proposals.
While Biden would set a corporate rate at 28% and Trump would sustain the current 21%, “the rate itself is kind of noise,” Barton says. “Whether it’s 28% or 21% doesn’t matter; what matters is what a company pays. Both plans want to make sure companies don’t escape the U.S.’s tax jurisdiction. Their anti-abuse provisions are similar, and both sides have talked about how to foster infrastructure builds—but both need to put more down on paper.”
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