Former Vice President Joe Biden is projected as the next president of the United States, and with a new president comes new policies. Of particular interest to investors and individuals alike are changes to tax policy and the potential implications.
While Mr. Biden has indicated he does not plan to repeal the Tax Cuts and Jobs Act of 2017, he does want to repeal parts of the law, focusing on increases for those households with income above $400,000. His plan is estimated to raise between $2 trillion and $3 trillion in revenue over the next 10 years according to the American Enterprise Institute and the Tax Policy Center.
To pass a tax increases both the House and Senate need to pass a bill, something that is unlikely with a divided Congress. We’ll have a clearer picture of the Senate after the January run-off that will conclude the race in Georgia. Of course, pieces of the proposed changes could be used as bargaining chips for other policies, but there hasn’t been much compromise in Washington lately.
Here are some of the key takeaways from the proposed changes:
- Increasing the top individual tax rate to 39.6% from 37%
- Expanding the estate and gift tax by reducing the exemption amount to $3.5M and increasing the top rate for estate tax to 45%
- Imposing Social Security payroll tax on wages above $400,000. The 2021 payroll tax earnings cap is $142,800, in effect creating a donut hole where no tax is paid on wages between $142,800 and $400,000.
- Increasing the long-term capital gains and qualified dividends tax rate to 39.6% for those with income above $1 million.
- Limits the tax benefit of itemized deductions to 28% for households with income above $400,000.
- Restores the Pease limitation on itemized deductions for household with income above $400,000
- Eliminating the stepped-up cost basis for inherited assets.
- Increasing the corporate tax rate to 28% from 21%
- Expanding the Child and Dependent Tax Credit to $8,000 from $3,000, with a $16,000 limit for households with more than one dependent.
- Expanding the Child Tax Credit to $3,000 from $2,000 for kids ages 6 to 17 and $3,600 for children under age 6.
- Reinstate the First-time Homebuyer Tax Credit – with a maximum of $15,000
- Student debt help including more generous forgiveness and payment-deferral rules.
Last year the campaign also supported repealing the $10,000 cap on state and local tax deductions, however it’s unclear where that issue stands currently. This is an important deduction that would aid households in high-tax states and those with large property tax bills in expensive real estate markets.
What’s the impact?
The majority of the increases would hit the highest-income households the hardest. In 2021 taxpayers in the top 1% would see their after-tax incomes reduced by around 11.3%, those in the top 5% could see a reduction of about 1.3% and filers in the 90th to 95th percentiles would see a slight reduction of about .2% according to the Tax Foundation. Those with lower incomes would see an increase in their after-tax income largely due to the expanded credits.
The repeal of the stepped-up basis would be very costly to all heirs not just the wealthy, this comes on the heels of costly rule changes for beneficiaries of inherited IRAs instituted by the Secure Act of 2019. Why does this matter? Assume you inherit $500,000 of stock from your Grandfather and he paid (cost basis) $100,000 to purchase it. Instead of receiving a stepped-up basis to $500,000, you would now owe income tax on the $400,000 gain in the stock.
How about the stock market? If changes do happen, they aren’t immediate and it’s impossible to predict the end-effect. For example, Presidents Ronald Reagan and George W. Bush implemented tax cuts during their administrations. If you had invested $100 in the S&P 500 at the start of each of their administrations, it would have grown to $324 under Reagan and declined to $70 under Bush2. In 2013, the Bush tax cuts expired for those making more than $400,000, in effect, this was a tax increase on income above that range. The S&P 500 increased in 2013, 2014, 2015, and 2016; highlighting that the tax increases did not cause a market collapse, a worry that many have during times when we experience tax hikes. Investors should be careful to extrapolate the impact of tax policy on their portfolios. We’ll remain focused on buying good companies, your goals, and long-term financial plan.
American Enterprise Institute – aei.org
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