What Would Biden’s New Tax Plan Mean for You?

Our topic on this episode of the Ready for Retirement podcast is about how Biden’s new tax plan may affect your financial goals. 

Biden’s proposed tax plans come with many changes and knowing the right questions to ask ourselves can help us navigate the changes so we can stay on course with our financial plan.

A few questions to ask ourselves include: Should I think about realizing capital gains if I am in a higher income bracket? Should I pay more medical expenses now if I know I will be having a major medical expense in upcoming years? Should I front-load charitable expenses? Should I do a Roth conversion? 

All of these questions are discussed below with in-depth answers to help you stay on track and in control of your financial future.

Key Points

• Biden’s Tax Plan
  • Potential changes with Biden’s proposed tax plans:
    • Tax Rate Changes
      • The top tax rate will likely increase. The top federal tax bracket is currently 37% and will revert back to 39.6%
        • However, the 39.6% tax bracket is likely to begin at $400,000 for both Single and MFJ households. 
        • Today, the top bracket is $518,400 if you file as a Single household. If you file MFJ, the top tax bracket is $622,000. With the proposed change, 37%  becomes 39.6% and the income tax threshold decreases to $400,000. 
        • Biden’s website doesn’t clarify if the $400,000 is for households filing for Single/MFJ.
    • Capital Gains Rates
      • Today Capital Gains rates are taxed between 0% – 20% depending on your income. Capital Gains taxes are 0%, 15%, or 20% on the federal level.
      • Instead of paying between 0-20%, Biden’s plan proposes 39.6% as a capital gain as you will no longer be receiving preferential tax treatment if you make greater than $1,000,000.
      • Today there is a 3.8% Net Investment Income tax that occurs if your income is greater than $250,000.
        • Today, the top Capital Gains tax rate is 23.8%, a combination of a 20% capital gains tax based off of your income and 3.8% NII (Net Investment Income Tax)
      • Biden’s tax plan proposes moving the top capital gains tax rate from 23.8% to 43.4%, which comes from the 39.6% (same as Ordinary Income) & 3.8% Net Investment Income tax.
      • Realizing Capital Gains today may be a tax-planning strategy as you anticipate taxes may rise in the future. 
        • Realizing gains today will lower your future capital gains tax bill.
        • Dividend investing from high-income earners may diminish as new tax rates are implemented. 
  • Social Security Tax
    • Today, Medicare & Social Security are funded through payroll taxes which you may hear as “FICA taxes”. 6.2% are withheld from your check for Social Security and 1.45% is withheld for Medicare.
      • Today this is capped at $137,700 for 2020. On the first $137,700, you will pay the full 6.2% Social Security tax. Once you are above that limit, it is still fully taxable at the Federal or State level, but you do not continue paying Social Security tax. However, Medicare tax continues regardless of your income.
      • Biden is proposing on wages over $400,000 you would have Social Security re-implemented.
        • You would pay taxes on the first $137,700 for Social Security and once your income reaches $400,000 you will once again pay taxes for Social Security.
        • Social Security is not taxed for the $262,300 in between $137,700 & $400,000.
  • Itemized Deductions 
    • Biden is proposing Itemized Deductions to be capped at 28% of their value.
      • Example: If you are in the top tax bracket today and you wish to donate $10,000 to charity, $10,000 comes off your taxable income and reduces your taxes by $3,960 ($10,000 x 39.6%).
      • Under the new proposal, that same $10,000 donation would reduce taxes by $2,800, not $3,960.
  • Flat Tax Credit for Retirement Plans
    • Example: Let’s assume you’re in a 12% tax bracket and you contribute $10,000 to a 401(k). This saves you $1,200 in taxes. If you are in the 35% tax bracket, you would save $3,500 in taxes.
    • Under the new proposed tax bracket, instead of your tax deduction being based on your federal tax bracket, there may be a flat tax credit. 
      • There is no current data on what that flat tax credit may be.
      • However, the Tax Policy Center did an analysis to find out at what point this tax credit would be revenue neutral.
        • Revenue neutral is the point at which the IRS wouldn’t add any money nor lose any money collected.
        • In other words, how can this be implemented without impacting the revenue collected by the IRS? This was found to be at 26%.
          1. If you currently are under the 26% tax bracket federally, you may get a tax benefit more than you are getting today.
          2. If you are over the 26% tax bracket, you would receive a better benefit today compared to if this new policy was implemented.
      • How does this impact your retirement plan?
        • If you’re in a higher tax bracket, you may forego pre-tax contributions.
          1. If you’re in a high income tax bracket today and contribute to your 401(k), you’re not receiving a full tax deduction for making that contribution and you would be responsible for paying taxes upon the withdrawals in retirement. 
      • Households may elect to make Roth contributions to forego tax benefits today to receive tax-free income in the future.
        • Individuals in low tax-brackets may make a pre-tax contribution to their 401(k) or IRA if these new changes were to be implemented. 
  • Business Changes
    • Corporate Taxes
      • President Donald Trump adjusted the corporate tax rate downwards from 35% to 21%.
      • President-elect Joseph Biden is proposing a corporate tax rate shift from 21% upwards to 28%.
    • It is proposed that if you are a qualified business, you have the option to take advantage of a qualified business income deduction where you may take advantage of a lower income tax rate of 20% depending on other income factors.
      • Under the current plan, this will likely be phased out for those businesses earning more than $400,000. 
  • Real Estate
    • It is proposed like-kind exchanges will be repealed that allow real estate investors to roll from one property to another tax-free. 
      • This is also known as a 1031 exchange
    • Example: Let’s take a rental property worth $500,000 that you bought for $200,000. As of right now, if you would like to buy another rental property, you do not have to sell the home and pay taxes on the $300,000 in capital gains as long as you abide by the 1031 exchange standards. 
    • The cost basis would transfer over to the new home. As long as both are rental properties, you may sell your current home,  purchase a new home, and your cost basis of $200,000 would transfer over to your new property. 
      • If this were to be repealed, real estate investors would realize a capital gain upon selling the property and use the remaining proceeds to invest in another property.
    • Limiting the amount of real estate investors earning over $400,000.
    • Disallow real estate investors to write-off losses depending on your income.
  • Estate Planning
    • As of now, if you were to pass away, there is a tax on your estate. The estate tax is currently 40%. However, there is an Estate Tax exemption on the first $11,480,000 (single) & $23,600,000 (MFJ)..
    • The new proposal would mean the Estate Tax exemption would likely decrease from $11,480,000 (single)  to ~ $3,500,000 (single).
    • Proposal of an elimination of the step-up in cost basis.
      • Example: If your parents bought Apple Inc. stock (AAPL) 20 years ago for $20,000 and it is now worth $700,000, there would be a $680,000 Capital Gains tax. 
      • However, if your parents pass away and you were to inherit Apple Inc. stock (AAPL), there is a step-up in cost basis, which would make the $700,00 the new cost basis.
        • If you were to inherit and sell Apple Inc. stock (AAPL) right away and it was valued at $700,000, there would not be a capital gain. 
• When will these changes impact me?
  • If the Republican Party is able to keep control of the senate, the likelihood of this being passed is substantially lower than if the Democratic Party were to control the senate.
  • This is likely to happen in 2022 and depending on which party controls the Senate. 
• Things to think about today:
  • Do I think about realizing capital gains if I am in a higher income bracket?
  • Should I pay more medical expenses now?
  • Should I frontload charitable expenses?
  • Should I do a Roth conversion?

Timestamps

1:00 – Overview of Biden’s Proposed Tax Changes

3:48 – Federal Tax Rates

5:57 – Should I realize Capital Gains now?

7:40 – Social Security / Medicare 

10:20 – Itemized Deductions

13:25 – Flat Tax Credit for Retirement Plans

17:15 – Real Estate

23:00 – Strategies to Implement Today

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