3.29.21 | BERDON VISION
The tax proposals set forth by President Biden will likely result in a tax increase for high income individuals, with tax credits and other assistance for lower income individuals. The majority of the proposed legislation will impact individuals with income over $400,000. President Biden’s tax proposal includes an increase in the top marginal income tax rate, taxing long term capital gains and qualified dividends at ordinary rates, capping tax benefits for itemized deductions, increased employment taxes, and a phase-out of the qualified business income deduction.
The current individual tax rate and other Tax Cuts and Jobs Act (TCJA) provisions affecting individuals expire at the end of 2025.
Ordinary, Long Term Capital Gain and Qualified Dividend Tax Rates
Currently, the top income tax rate sits at 37% and is scheduled to revert back to 39.6% at the end of 2025. President Biden’s tax proposal looks to accelerate the expiration of the current top rate as early as 2021 (possibly 2022), for households with income over $400,000.
Investment income from long term capital gains and qualified dividends are currently taxed at a top rate of 23.8% (20% income tax plus 3.8% net investment income tax). Under the President’s tax proposal, the top long-term capital gain and qualified dividend tax rate would be increased to 43.4% (39.6% income tax + 3.8% net investment income tax) for income above $1 million.
Planning Opportunity: Taxpayers should be working with their investment and tax advisors to develop a long-term approach to asset allocation based on the possible law changes. Further, individuals that rely on their annual income from qualified dividends and capital gain distributions should review their after-tax cash flow calculations to assess the impact of an additional 19.6% of income tax.
To learn how President Biden’s proposed repeal of the step-up in basis of a decedent’s assets at death may impact heirs, click here.
The number of individuals that itemize deductions has decreased since the enactment of the TCJA, which capped the state, local and property tax deduction at $5,000 ($10,000 for married filing joint (MFJ) taxpayers), removed miscellaneous 2% deductions, and increased the standard deduction to $12,200 for single taxpayers ($24,400 for MFJ taxpayers). Individuals that currently itemize deductions have charitable contributions, mortgage interest expense, and investment interest expense in excess of the standard deduction. Total allowable itemized deductions receive a dollar for dollar deduction against an individual’s adjusted gross income.
President Biden’s tax proposal seeks to cap the tax benefit of itemized deduction at 28%, for individuals in a 28% or higher tax bracket. This is coupled with the possible removal of the cap on state, local and property tax deductions. Biden would also like to restore the Pease limitation, which reduces itemized deductions by 3% of adjusted gross income in excess of a threshold amount. These tax proposals would apply to households with income over $400,000.
Phaseout of the Qualified Business Income Deduction (QBID)
The QBID was introduced by the TCJA. Individuals with certain types of business income and REIT dividends receive up to a 20% deduction against this income, effectively lowering the top income tax rate on qualified business income to 29.6% (37% * 20%). Biden’s tax proposal would phaseout the QBID for taxpayers with income over $400,000. This would increase the marginal tax rate for affected taxpayers currently eligible for the QBID by 10% (39.6%-29.6%), or about 1/3. To learn more about the QBID’s impact on business owners, click here.
Trusts are taxed similarly to individuals, but with top tax rates kicking in at a much lower threshold ($12,950 of ordinary taxable income). Trusts are eligible for favorable long-term capital gain and qualified dividend rates, are not subject to the Pease limitation on itemized deductions, and are eligible for the QBID. The foregoing Biden tax plan also impacts trusts and many of the planning points and strategies are equally applicable to them.
Increased Employment Taxes
The current employment tax structure includes a 12.4% (6.2% employee share) Social Security tax on wages up to $142,800, 2.9% Medicare tax on full wages (1.45% employee share and no cap) and a surtax of .9% on wages above $200,000 ($250,000 MFJ). Under the President’s plan, the Social Security tax exemption would be eliminated for wages over $400,000, with no Social Security tax on income between $142,800 and $400,000. The Social Security tax is split between the employee and the employer. These parameters apply equally to the Social Security Tax component of self-employment income, which is borne entirely by the self-employed individual. To learn more about the impact of additional social security tax on employers and business owners, click here.
If you have any questions on income tax planning in light of Biden’s tax proposals, please contact Veronique Horne at 212.331.7631 | firstname.lastname@example.org or Scott T. Ditman at 212.331.7464 | email@example.com or reach out to your Berdon tax advisor. We are just a phone call (or Zoom call) or e-mail away.
Berdon LLP New York Accountants