What the Biden Tax Plan Could Mean for You

 In Tax Planning

When new tax legislation is proposed or expected to be introduced, economists, think tanks, journalists, tax policy experts (and really, anyone with an opinion) begin disseminating information regarding how the legislation will impact taxpayers. I am always skeptical of expressing opinions on new tax legislation because it is a moving target. The Biden tax plan is no exception.  What the policy looks like when it is introduced is almost never what it looks like when it is enacted, which is almost never what it looks like when regulations and interpretations are released post-enactment. The process of our elected officials reaching compromises so that legislation can get enough votes to pass, along with cuts and additions that are made so that budgetary restrictions are met is an arduous and complicated process. But those of us who work in the tax area cannot ignore what is potentially on the horizon that could impact our clients.

Take This Article with a Grain of Salt!

Here are my disclaimers for those who are reading this article, which are generally applicable to any article you may read about tax policy.

  1. Information is Subject to Change– Keep in mind that when you read anything about the Biden tax plan, that you are reading about the tax plan that existed at the time the author wrote the article. President Biden’s tax plan is frequently updated, and this is likely to continue to be the case due to the widespread and complex economic impacts of the COVID-19 pandemic. By the time you read this, some or all of the provisions I am writing about may have changed.
  2. Political Bias– Also consider that whenever you read about tax policy that it is generally written from whatever political slant the authorship, media entity, or policy organization may have. It is very tough to get unbiased information on tax policy. Though I do have a party affiliation, I am a moderate (especially with respect to tax and economic policy), and I will try to be as politically neutral as I can in this article. If I do not accomplish that in your view, I apologize in advance!
  3. Difficulty of Passing Legislation– Getting our elected representatives to agree on enough terms to have legislation pass is oftentimes difficult. This can be the case even within a single political party. However, getting legislation passed may be especially difficult given the current narrow margin in the Senate (split 50/50 between Republicans and Democrats with a potential tie-breaking vote cast by Vice President Kamala Harris) and the current filibuster rule that remains in place at the time I write this article (requiring a supermajority of votes for legislation passed outside of budget reconciliation). Thus, we cannot make any assumptions about what may or may not get passed in Congress before it would even reach the President’s desk. Though legislation is sometimes passed along strict party lines, moderates in both parties are oftentimes willing to break with the majority in their respective caucus due to personal principle, the concerns of constituents in their respective districts, or their views on the quality of the legislation itself.

So essentially, take all of what you are reading with a grain of salt (as with anything else you read on the Biden tax plan). Information is subject to change, there is a possibility that it will be very difficult to get tax legislation passed with the current balance of power in Congress, it is difficult to determine its legislative priority compared with the pandemic and other important issues in our country, and lastly, I could simply be wrong about how I interpreted the information I have read on this topic. Anyone who wants to know more about how current or potential legislation will impact them personally should seek advice from the tax professional who is most familiar with their tax situation.

Is Biden’s Tax Plan a Repeal of Trump’s Tax Cuts & Jobs Act?

President Biden’s tax plan could be partly viewed as a repeal of President Trump’s Tax Cuts & Jobs Act (TCJA), but some elements of the TCJA appear to be retained in the Biden tax plan, some provisions from the TCJA are expanded upon, and there are some new items in President Biden’s plan that do not exist under TCJA. A situation that may be fresh in the memories of many is the efforts of the previous administration to repeal the Affordable Care Act, the law many people know simply as “Obamacare”. One of the teachable moments from the ineffective efforts to undo comprehensive legislation of a predecessor is that completely undoing a major law may not be the best way to solve problems with the legislation. Oftentimes it is better, and in my opinion smarter, to modify existing legislation rather than to repeal major legislation that affects millions of Americans and start from scratch.

There are many parts of the TCJA that both sides of the aisle can agree have made tax policy simpler and better for many taxpayers. Here is a shortlist.

  1. Increased Standard Deduction– The TCJA doubled the standard deduction, which drastically reduced the number of taxpayers who itemize deductions. I have read estimates that before the TCJA, 30% of taxpayers itemized deductions and now only 10% of taxpayers itemize deductions. I have also seen this occur in returns I prepare for some of my clients. The increased standard deduction results in a simpler tax compliance burden for many Americans, it results in tax savings for taxpayers who were generally unable to itemize, and it reduces the administrative burden on the IRS with respect to policing itemized deductions.
  2. Flat Corporate Rate– The TCJA changed the corporate tax rate from a progressive rate that increased with corporate income (ranging from 15% to 35%) to a flat rate of 21% for all C Corporations. This significantly decreased the tax compliance burden of corporations, simplified corporate tax planning, and resulted in significant tax savings for the largest corporations that had a previous marginal rate of 35%. How you feel about that last statement may depend on which side of the aisle you fall on. But regardless of political affiliation, if you have stock investments, perhaps you do care to some degree about corporate profits (as that affects the balance in your investment accounts). As with the increased standard deduction, a flat corporate rate also reduces the tax administration burden on the IRS.
  3. Increased Child Tax Credit– The TCJA doubled the child tax credit from $1,000 per qualifying child to $2,000 per qualifying child. This change resulted in significant tax savings for many American families, and it is one of my favorite provisions of the TCJA. Many of my clients benefited from this provision.
  4. Better Tax Brackets for Individuals– Based on tax bracket considerations alone, most taxpayers pay less tax under TCJA than they paid prior to TCJA. What I mean here is if you take a taxable income figure under TCJA and compare the marginal tax rate to what would have applied pre-TCJA, it is likely that the marginal tax rate is lower under TCJA. Whether it works out to less tax overall once the entire tax picture is factored in is a completely different story.

So, having said that, it does not appear to be in our collective best interest to throw away the entire TCJA, as it did not appear to be in our collective best interest to throw away the entirety of the Affordable Care Act. So far, it appears that President Biden understands this, and wants to keep in place as much of the TCJA as he can that benefits individuals with income under $400,000. That $400,000 figure is seen throughout many aspects of President Biden’s tax plan, and the interpretation seems to be that this number represents “high income” individuals. One challenge with bright-line rules like this though is that $400,000 in New York and $400,000 in Idaho do not represent the same financial situation. But let’s face it, most taxpayers likely would not have sympathy for a taxpayer that makes $400,000 in either situation, and that is why targeted legislation like this polls so well among the majority of the American people. Also, this $400,000 appears to apply regardless of filing status. $400,000 for a single person compared to $400,000 for a married couple is a significantly different situation. In addition to individuals with income over $400,000 another key demographic that will see increased taxes under Biden’s tax plan is C Corporations.

What Are Some Key Aspects of Biden’s Tax Plan?

Here is a shortlist of some of the provisions of the Biden tax plan. Experts are predicting that if these changes are implemented, most are expected to be effective in tax year 2022 or potentially in 2023.

  1. Corporate Tax Rate Increase– The corporate tax rate will be raised from a flat rate of 21% under TCJA to a flat rate of 28% under Biden’s plan. For the largest corporations, the 28% is still an advantage as compared with their previous marginal rate of 35%, but for smaller corporations, this change may significantly increase their tax burden to a degree that C Corporation status is no longer optimal.
  2. Individual Top Bracket Increase– The top individual marginal tax rate will revert back to 39.6% (pre-TCJA levels) as opposed to the 37% top marginal rate currently applicable under TCJA. The remaining brackets are expected to remain similar to those under TCJA (until the individual provisions sunset in 2025).
  3. Increased Social Security Tax (with a “Donut Hole”)– For tax year 2021, the maximum wages subject to Social Security tax (for the employee and employer) is $142,800, and this amount is indexed for inflation each year. Under President Biden’s plan, this cap will continue to apply and increase for inflation each year, and for most taxpayers the Social Security tax will stop there. However, once an individual’s wages reach $400,000, the social security tax picks up again for both the employee and employer. The gap in between the cap that applies to most taxpayers, $142,800, and the $400,000 where Social Security tax is imposed again is known as the “Donut Hole”. Because the $400,000 figure is stable and not indexed for inflation, it is expected that the Donut Hole will eventually close over time and that eventually, all earnings will be subject to Social Security tax, similar to how Medicare tax on wages is currently assessed on unlimited earnings.
  4. Phase Out of Qualified Business Income Deduction– The TCJA implemented the Qualified Business Income Deduction, which is a 20% deduction on net income from pass-through entities on an individual taxpayer’s return. Currently, there is the potential for no phaseout of the deduction due to income, provided that the business has an adequate amount of wages and/or investment in capital assets. Under President Biden’s plan, the Qualified Business Income Deduction will phase out for incomes over $400,000, despite such investment in wages and capital assets.
  5. Increased Child Tax Credit, Earned Income Credit, and Dependent Care Credit– The amount of Child Tax Credit under President Biden’s plan is expected to increase from $2,000 per child to $3,000 per child (for qualifying children ages 6 – 17) or $3,600 per child (for qualifying children under 6). Child and Dependent Care Credit is expected to increase from $3,000 per child/$6,000 per family to $4,000 per child/$8,000 per family and phase out at incomes over $400,000. The limit on income applicable for Earned Income Tax Credit is raised by about $5,000, the maximum credit for childless adults increases by about $1,000, and the age limitation is eliminated for older workers. Currently, these provisions are expected to apply only to 2021.
  6. Retirement Plan Contributions (Credit vs. Deduction)– Under current law, individual contributions to a 401k plan or IRA result in a tax deduction. This means that your tax savings as the individual contributor will depend on your marginal tax bracket. For example, if you contribute $1,000 to your 401k and you are in the 10% bracket, you will save $100 in federal taxes by contributing to your 401k. If you are in the 37% bracket, you save $370 in federal taxes by contributing to your 401k. Under President Biden’s tax plan, rather than a deduction that reduces federal taxable wages, each taxpayer would receive a refundable credit (predicted to be around 26%) for contributions to their retirement account. So, for both taxpayers mentioned in the previous example, each of them would get a credit worth $260 of tax savings. This is another example of providing a tax benefit to those with less income in exchange for increased tax burden for those with more income. What is not mentioned is how this would impact tax benefits at the state level, as the deduction generally results in tax savings for both federal and state (where the state tax system is in conformity with federal). So, the jury is still out on the nuts and bolts of this one, and it will be interesting to see whether states will add a credit to accommodate for the lost deduction on the state side of things or if states will seize the opportunity for additional revenue if this tax provision is implemented.
  7. Cap on Itemized Deductions– The tax benefit of itemized deductions will be limited to 28% of their value for taxpayers with income above $400,000.
  8. Other Provisions (that Likely Won’t Affect My Clients)– There are some other incentives in Biden’s tax plan for manufacturing companies, additional capital gains tax for taxpayers with income over $1,000,000, international taxpayers with GILTI income, some estate and gift tax changes, and other provisions in the plan that will not affect the majority of my current client base, so I am excluding them here. If you fall into one of those categories, definitely do further research on this plan and consult tax professionals who advise clients in those areas frequently.

As always with anything you read, do further research on anything that sparks thought and consult your tax professional about how these provisions, if passed, may affect you. However, this truly is a plan that aims to target tax increases for high-income taxpayers and C Corporations, so if you are not in one of those categories, according to the research I have done your tax burden is not likely to increase under President Biden’s tax plan. But if you are in one of those categories, stay engaged in the topic, communicate with your tax professional, and do the best planning you can so that you pay the correct amount of tax for your situation (and not a dollar more).

If you have questions regarding how potential tax legislation may affect you, feel free to contact me using the form below.

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