Proposed Tax Changes: What You Need to Know
Last week, the White House introduced the $2 trillion American Jobs Plan to bolster America’s crumbling infrastructure and invest in R&D. Both Democrats and Republicans as a whole have voiced their support for infrastructure spending, though the two parties are miles away from agreeing on how to pay for it and even really agreeing on how they define “infrastructure.” In the post below, we will discuss what President Biden is proposing, what compromises we may expect, and some ideas of how to plan ahead.
Higher Corporate Taxes
Top priority seems to be increasing the corporate tax rate. President Biden has proposed raising the statutory rate from 21% to 28%. The rate was lowered by President Trump back in 2017 from 35%, so this move is dialing that back by half. According to the White House, the "Made in America Tax Plan" is intended to incentivize job creation in the U.S. and end profit-shifting to tax havens so that large corporations pay "their fair share."
Democrats see the corporate tax rate as a number that they can start with because the average working-class voter typically feels that Big Business can spare some change. However, Republicans argue that increasing our corporate tax rate will make the U.S. less competitive and encourage companies to take their business elsewhere. To combat this, President Biden and Secretary of Treasury Yellen are calling for other countries to adopt a minimum tax on corporations. They are also seeking to make it harder for companies to merge with foreign businesses to avoid paying U.S. taxes.
Ultimately, the final number for the corporate tax will probably fall somewhere around 25%. President Biden has signaled that he is willing to negotiate and wants to get this done. The effective tax rate that companies pay on average will probably fall around 20-21% which is a slight increase from the 18-19% that companies averaged over the last 2 years.
It is also important to remember that the corporate tax rate only applies to C-corporations. Data shows that only about 5% of businesses are structured as C-corps so for most people, the corporate tax rate is not on their radar. The greatest impact of this change will be felt by stockholders of publicly traded companies. Estimates show that stocks may see a 6% hit to earnings based on this tax change, however economic growth may offset the tax hit.
Closer to home: Individual Tax Increases
Throughout his campaign, Biden expressed his intention to raise taxes on those earning over $400,000. This means the top ordinary income tax rate is likely to go up to 39.6% (This was the top rate before the TCJA of 2017).
In addition to this, there may be changes to the Qualified Business Income Deduction which applies to pass-through corporations and affects the majority of small business owners. This deduction has been popular and is likely to remain in some form but be phased out for income over $400,000.
Other Rumored Proposals:
While the current infrastructure proposal is relying on the corporate tax rate change, there are additional spending programs that are going to be introduced and there have been rumors of what other tax programs may accompany these proposals. Here are a few that seem likely:
Eliminate the step-up in basis at death. Currently, an asset receives a step-up in cost basis when the owner dies. This means that when someone inherits an asset like stocks or real estate that has grown in value significantly over time, they would avoid paying taxes on the gain if they immediately sold the asset. The cost of the asset is immediately “stepped up” to the value of the asset on the date the owner dies. By eliminating this rule, the government would likely raise a lot of revenue through the sales of inherited assets.
Replace the deduction for IRAs and 401(k)s with a flat 26% credit. This change would affect people proportionately based on income. It is likely that higher income individuals would lose some tax deductibility of retirement contributions, while there would be greater incentive for lower- and middle-income individuals to save for retirement.
Increase capital gains rates on income $1,000,000 and over from 20% to 39.6%. This would have a big impact on the sale of assets for high-net worth individuals. Under Biden’s plan, capital gains will likely be progressive much like our income tax rates. Some states, like CA, already approach capital gains like ordinary income.
Lower the uniform gift and estate tax exemption to $3.5 million for individuals and $7 million for married couples from $11.58 million and $23.16 million respectively. The gift and estate tax exemption is not a tax that most households really consider right now because the exemptions are so high. This may change and we may be returning to levels that we saw during the 2000’s.
Don’t Lose Perspective
All of this talk about taxes can be aggravating. Remember that right now, these are just the numbers that are being proposed. As with any negotiation, the first numbers don’t usually end up being what is agreed upon.
Also, most of these proposals are situations that we have dealt with before and we know that there are planning strategies that can help us prepare for whatever tax laws are eventually passed.
Planning strategies to consider:
Be proactive about projecting annual income each year and take action on ways to reduce excess ordinary income: pre-tax retirement plan contributions, charitable donation strategies, moving high tax investments to tax-deferred or tax-free accounts, using municipal bonds in taxable accounts.
Consider Roth contributions and Roth conversions as a way to build up future tax-free income.
Evaluate highly appreciated assets and determine exit strategy plans. Be conscious of rebalancing annually to maintain target risk allocations.
Taxes are inevitable, but we can be active in trying to reduce them as much as possible. Don’t forget to reach out to review your tax return and plan ahead.
Bonus: Where is the money being spent?
Since this post is discussing how the government plans to raise revenue, it would also be helpful to understand where they are proposing this money is being spent. According to the White House, there are four main parts of the proposed plan:
Transportation Infrastructure: $621 Billion. This would be a massive investment into roads, railways and bridges. In addition, this part includes a focus on clean energy. This focus would come through building a network of charging stations for electric vehicles and also offering incentives for electric cars. In addition government fleets would be replaced with electric.
Quality of Life at Home: $650 Billion. This is the largest part of the plan and goes toward improving homes, schools, underground water infrastructure and broadband access.
Caregivers for the elderly and disabled: $400 Billion. This is focused on improving access and affordability of care.
Research, Development and Manufacturing: $300 Billion. This part is focused on increasing our competitive advantages in research and development. Specifically in manufacturing and development of technology and critical goods.