During the election campaign, President-elect Joe Biden proposed a tax plan that departs significantly from the policies and major tax reductions enacted during the Trump presidency. The Biden plan would increase tax rates for individuals whose incomes are $400,000 and higher as well as for corporations which also would be subject to a new minimum tax on book income.
In announcing his economic stimulus plan, President-elect Biden outlined a number of major tax changes. The Biden Administration’s initial tax legislative efforts likely will focus on the passage of the tax proposals related to reviving the economy, including benefits targeted for low- and middle income families.
- The top individual federal income tax rate would rise from 37% to the pre-Trump rate of 39.6%.
- The corporate rate would rise from 21% to 28%; a 15% alternative minimum tax would apply to corporate book income of $100 million and higher.
- Individuals earning $400,000 or more would pay additional payroll taxes.
- The maximum Child and Dependent Tax Credit would rise from $3,000 to $8,000 ($16,000 for more than one dependent).
- Tax relief would be offered for student debt forgiveness and the first-time homebuyers credit would be restored.
- The estate tax exemption would drop by about 50%.
The Social Security tax would be extended to higher income levels, the estate tax exemption would be reduced by approximately 50%, and step-up in basis on death would be repealed.
Outlined below are the key elements of the Biden tax plan, as currently available. Note that all these changes would need to be enacted by Congress in order to become law, and any of its provisions may be revised or eliminated. With the Democratic victories in the Georgia Senate run-off races, the Congressional tax-writing committees will both be chaired by Democrats.: Representative Richard Neal of Massachusetts will lead the House Ways and Means Committee again and Senator Ron Wyden of Oregon will become new chair of the Senate Finance Committee.
The COVID pandemic and its economic fallout are likely to dominate legislative activity and focus attention on a stimulus program including some tax provisions. Beyond the stimulus package, the one-party, albeit marginal, control of both Houses and the White House creates a greater potential for consideration for additional tax proposals by the current Congress later in the session.
Restoring Higher Tax Rates and Alternative Minimum Tax
The President-elect’s tax plan would repeal the major tax reductions passed in 2017; it would increase the top individual federal income tax rate from 37% to the pre-Trump rate of 39.6% and the corporate rate from 21% to 28%. For individuals with incomes of $400,000 or more, the tax benefit afforded itemized deductions would be capped at 28%, rather than the percentage tax rate applicable at higher tax brackets. Tax rates would be graduated so that individual taxpayers with incomes below $400,000 would not see rate increases.
The “carried interest” loophole would disappear, and those earning $1 million or more would pay ordinary income tax rates on investment income.
Wealthy individuals. To make the tax treatment of wage-earners and wealthy investors similar, taxpayers whose income exceeds $1 million would pay the same rate on investment income as applies to wages. In addition, the carried interest “loophole,” claimed by many private-equity and hedge-fund managers, would be eliminated. These fund managers pay capital gains tax rates—currently levied at 20%—instead of ordinary income rates on their “carried interests,” i.e., high, fixed-rate participations in their funds’ profits, while making little or no capital investment.
Corporations. The corporate tax rate would increase from 21% to 28%. To prevent profitable companies from paying no tax, all corporations would be subject to a 15% percent alternative minimum tax (AMT) on book profits of $100 million or more. These corporations would be liable for the greater of the regular tax or the AMT.
The plan would penalize penalize exporting jobs overseas and incentivize investments in infrastructure and green energy, transportation, and manufacturing. It would increase taxes from 10.5% to 21% (up to 26.5% in 2026) on Global Intangible Low-Taxed Income (GILTI). Businesses would be offered a variety of new tax credits, ranging from benefits to deal with workforce layoffs to small business incentives to provide retirement savings plans.
It is difficult to predict or quantify what, if any, impact these tax changes might have on corporate stock valuations—and, thus, on the value of stock portfolios and retirement savings. Any effect on stock values probably would depend on the extent to which individual corporations had benefited from the provisions that the Biden plan would reduce or eliminate. With respect to the proposed AMT on book income, the key factor would be the extent to which the income reported for financial purposes exceeds the income reported on their corporate tax returns.
Benefits for Individuals and Families
The Biden tax plan also emphasizes new and revised tax benefits for “working families.” A key element of the President-elect’s policy is the use of tax credits, often refundable, rather than tax deductions, to counter the greater savings that deductions provide to higher-income taxpayers compared to lower- and middle-income individuals.
Child and dependent care. Two separate credits related to children are both part of Biden’s tax plan.
The President-elect’s plan would expand eligibility for the Child and Dependent Care Tax Credit and allow up to $8,000 in credits for qualified expenses for low- and middle-income working families. The change would increase the credit from a current maximum of $3,000 to $8,000 and provide a ceiling of $16,000 for multiple dependents.
The Child Tax Credit would be made fully refundable and rise from $2,000 to $3,000 per child for children ages 6 to 17, with a larger credit of $3,600 per child allowed for children under age six. President-elect Biden announced that these changes will be included in his economic stimulus package expected to be introduced shortly after the inauguration.
Retirement tax benefits. One significant potential substitution of a tax credit for a present-law deduction applies to retirement savings. The Biden plan would include rules, details unspecified, to equalize the tax benefits for contributions to 401(k)s and other retirement plans across the income scale.
Depending on the design of the new provision, the impact on high-income taxpayers could be substantial. For example, if the proposed revision of the 401(k) contribution benefit entitled a taxpayer with a marginal tax rate of 35% to a 20% tax credit instead of the present law’s tax deduction, the tax savings for the current, maximum annual contribution of $19,500 would decline from $6,852 to $3,900.
Health insurance costs. As part of the president-elect’s program to increase protections and assistance for health insurance access, the Biden plan would provide refundable tax credits for healthcare insurance premiums intended to limit families’ spending on insurance premiums to no more than 8.5% of their income. In addition, the plan would increase tax benefits for the purchase of long-term care insurance.
First-time homebuyer credit. Recognizing that home ownership is the foundation of family wealth accumulation, President-elect Biden would reinstate the first-time homebuyer tax credit, originally created to help housing in the Great Recession. This credit would be provided at a maximum of $15,000 for first-time home purchasers—and it would be refundable and advanceable in order to assist buyers at the time of purchase, instead of making them wait until they file their taxes.
Student debt help. The Biden tax plan would afford some tax relief for the burden of student debt, in addition to adding more generous forgiveness and payment-deferral rules for present student loan programs. Under the present law, the amount of any loan forgiveness granted a borrower generally must be reported as taxable income, thereby imposing a new, similarly challenging economic burden. The tax feature of the Biden student loan assistance would forgive the balance of a borrower’s outstanding student loan debt after 20 years without imposing any tax liability.
Increases in Payroll and Estate Taxes
Two features of the Biden tax plan directly target high-income taxpayers. The first provision would increase Social Security taxes, while the second would increase estate taxes.
Payroll taxes. For 2020, the Social Security payroll tax is 6.2% each for the employee and employer on wages up to the contribution base of $142,800 for 2021. Self-employed individuals are liable for Social Security tax of 12.4% on their net profits. The Biden plan would impose an additional Social Security payroll tax of 6.2% each on employer and employee on all earned income of $400,000 or more. Under the plan, no additional Social Security tax would be imposed on wages between the wage base of $142,800 for 2021, up to $400,000.
Estate tax exemption. The Biden tax plan entails two changes to the federal estate tax. It would reduce the estate tax exemption by approximately 50% from its current level of $11.58 million of estate assets, thereby restoring the threshold for taxable estates to its pre-Trump level. Tax experts generally believe that most very wealthy individuals already take advantage of sophisticated tax-planning strategies that reduce their estate-tax liabilities and will continue to do so. Therefore, the lower exemption level may result in expanded tax planning but only a minor increase in revenue.
Step-up in basis. The second change would repeal the present law “step-up in basis” rule that increases the tax basis for inherited assets to their full fair market value upon death. This rule—which ‘carries over’ an asset’s tax basis from the testator to the heir—likely would entail a significantly greater overall tax burden with respect to transferred assets than would the decreased exemption.
The current rule benefits all heirs, including those receiving modest assets such as decedents’ residences or mutual fund shares from estates valued below the estate tax threshold. Under present law, inherited property receives a full fair market value tax basis. As a result, if the property has appreciated in value since its acquisition by the decedent, the inherent increase in the property’s value as of its owner’s death permanently escapes capital gains tax. If the heir subsequently sells the property, the heir’s taxable gain will be limited to the increase in value over the stepped-up tax basis.
The repeal of the step-up in basis rule could prove very costly over time to heirs of appreciated property at all income levels, not just the wealthiest.
Because of the tax-avoidance benefit of the step-up in tax basis, wealthy owners of valuable, appreciated assets may retain ownership of such assets until they die, when any potential tax on the appreciation will disappear under present law. Thus, wealthy families can pass on significant wealth for generations without incurring any capital gains tax on the increase in value since the original acquisition of the asset.
While the step-up in basis provides important tax benefits to all wealthy families passing down appreciated assets, including art works, securities, and other property, from one generation to the next, it is an especially valuable tax benefit for families owning assets whose original tax bases have been reduced by depreciation even while the assets’ values have increased above their original cost.
For families with extensive, appreciated real estate investments, for example, the step-up in basis upon death creates a significant motive for tax planning. While real estate investors may hold onto property for generations, they also can diversify their assets during their lifetimes under the present tax code without having to pay tax on the increase in value. To diversify, they can use such tax-avoidance strategies as like-kind exchanges or contributions to partnerships or real estate investment trusts (REITs). These transactions allow tax-free, lifetime transfers but carry over the transferred realty’s depreciated tax basis to the real estate, partnership interests or REIT shares received for the exchanges or contributions. Any unrealized gain in the original property is reflected in the tax basis of the replacement assets.
Biden Tax Plan: Major Policy Shift
President-elect Biden’s tax proposals differ markedly from the tax policies pursued by the Trump Administration; indeed they would reverse major tax reduction legislation enacted during the Trump term. The Biden plan would restore prior rates and redesign benefits, e.g., changing some deductions to credits, to the advantage of lower- and middle income taxpayers.
Although not included in the official tax plan announced during the campaign, additional changes reportedly are under consideration, including repeal of the cap on state and local tax deductions, repeal of the like-kind exchange benefit for real estate, incentives for US job creation and a phase-out for deductions from “pass-through” entities, such as sub-S corporations, partnerships and trusts, for individuals with incomes of $400,000 or more.
Biden’s Proposed Changes
The Biden plan would reverse many of the 2017 changes. But, as noted above, it bars tax rate increases for incomes below $400,000. Instead, it emphasizes providing tax relief for individuals in the lower tax brackets and equalizing tax benefits for all taxpayers.
In addition, President-elect Biden would tax investment income of taxpayers whose income exceeds $1 million at ordinary income rates, impose higher Social Security and estate taxes on high-income and wealthy individuals, repeal the estate tax step-up in basis, and tax “carried interest” fund distributions at ordinary income rates.
The Bottom Line
Under the Biden, federal taxes imposed on corporations and wealthy and higher income taxpayers would increase. However, lower-income individuals’ rates generally would not change and families, in particular, would be entitled to expanded credits and deductions.
Frequently Asked Questions
Will the Biden tax plan increase my taxes?
That depends. Under the Biden plan, the tax rates on individual incomes below $400,000 would not increase. New and expanded tax benefits, including provisions for child care, first-time homebuyers, educational debt relief, retirement savings, health insurance, and long-term care insurance, could reduce taxes for average families.
However, it would increase taxes for corporations and for most taxpayers with incomes of $400,000 or more. It would reinstate the pre-2017 top marginal, individual tax rate of 39.6 %, substitute flat-rate tax credits for some deductions, including some contributions to retirement plans. Individuals with incomes of more than $1 million would pay the same rate on investment income as on wages, and equity and hedge fund managers would be subject to ordinary income rates on “carried interests.” In addition, the payroll tax for Social Security would apply to earnings of $400,000 or more (but not between the current wage base of $142,800 for 2021—up to $400,000). The estate tax exemption would fall back to $5 million and the step-up in basis at death for appreciated assets would be repealed.
What is a tax credit?
A tax credit is a direct offset to the amount of taxes owed by a taxpayer. It is a dollar-for-dollar reduction in tax liability. Unlike deductions—which reduce income—tax credits provide the same amount of benefit to all taxpayers regardless of tax bracket. Some tax credits are “refundable,” and thus particularly benefit taxpayers who owe less in taxes than the credit amount. Those taxpayers get a refund of the balance.
A 20% tax credit for an eligible expenditure of $100, will reduce taxes by $20 for every taxpayer regardless of income level or tax bracket. On the other hand, an exclusion, exemption, or deduction reduces income and thus provides a larger benefit to taxpayers in higher tax brackets. Some examples:
- For a taxpayer in the 37% marginal tax bracket, a deduction of $100 will save the taxpayer $37, i.e., 37% of the $100.
- For a taxpayer in the 24% marginal tax bracket, the savings will be lower, $24, i.e., 24% of $100.