We have a new President. We wish him well. President Biden, at least for two years, has a Democratic majority in the House and the Senate. There will likely be some major changes in tax policy during this time. While we don’t expect tax policy to be the first order of business for the new administration, we do believe, based on remarks during the election campaign, there will be significant changes in both income taxes and estate taxes, particularly for the wealthiest Americans. Review, planning and action are likely needed now.
Income Taxes. When candidate Biden announced his economic stimulus plan, he also announced some major proposed tax changes. It is expected that the Biden administration will likely focus on tax proposals to revive the economy, including benefits targeted for low-and middle income families. Here are some key areas:
- Increase the corporate tax rate- The 2017 Tax Cuts and Jobs Act (“TCJA”) lowered corporate taxes from 35% to 21%. Biden would raise them to 28%.
- Increase taxes on high earners – Biden would raise the top individual income tax rate from 37% to 39.6% (where it was in 2017).
- Phase-out the pass-through deduction – The 20% Qualified Business Income (“QBI”) deduction would be phased out for taxpayers earning $400,000 or more.
- Increase capital gains on higher earners- Currently there are three capital gains rates-0%, 15% and 20%. For taxpayers earning more than $1 million, Biden would add a fourth category and tax capital gains, for these folks, at ordinary income rates.
- Increase social security taxes- Biden would increase the revenue to social security by having workers earning more than $400,000 and their employers pay additional amounts of payroll taxes.
- Increase the Child Tax Credit- The maximum credit would rise to $8,000 ($16,000 for more than one dependent).
For most people earning less than $400,000, there should be little change. However, the “devil is in the details.” Depending on the timing of legislation, it is possible that changes could be made retroactive to January 1, 2021, though generally new tax policy starts on January 1 of the following year; in this case, 2022.
Estate Taxes. Possible changes in estate taxes could ultimately impact more of you than income taxes. Two key areas: lower exemptions and higher rates, and the “step-up in basis” rules.
The current federal lifetime gift/estate tax exemption is $11.7 million per person; hence, $23.4 million per couple. The current tax rate is 40% tax on anything above that level. Yes, we work with some clients who are above the levels, but most of our clients are below that amount. That could change.
It is expected that the exemption level could come down to $5 million per person and maybe even $3.5 million, where it was when President Obama took office. And, the rate might go up to 50%, or even 55%, where it was in 2001. At these levels, many of our clients and their families could be subject to estate tax. Please remember that exemption levels rise and fall due to its political nature. We don’t know when we will die and we don’t know what the estate tax rules will be at that time. Even so, every family needs to assess their estate plan annually based on their current and expected net worth and the current and expected estate tax rules.
The second possible major change would be to repeal the “step-up in basis” rule that increases the tax basis for inherited assets to their full fair market value upon death. For decades, assets of the decedent have been valued as of the date of death, regardless of how long the decedent had owned the property and how much they had paid for it and depreciated it. If assets were sold shortly after death, the beneficiaries would pay no or little capital gains taxes. Take, e.g., a commercial building worth $5 million that was purchased by the decedent 40 years ago and is fully depreciated with a zero net tax basis. Under current rules after the decedent passed, the beneficiaries could sell the building with no capital gains, or keep it, rent it and start depreciating it again using the $5 million basis. The so-called step-up basis rules have applied to all assets of the decedent- investments, homes, personal property.
Further, under current rules, families get a step-up in basis, whether or not the estate is subject to estate taxes. So, currently, most estates do not have estate taxes (since the estate is less than $11.7 million) but gets a full step-up in basis. Hence, a couple of modest means whose family home has appreciated significantly over the years would currently get a step-up on mom and dad’s family home and pay no capital gains if the beneficiaries sold it. That would change.
A Biden administration may push for this change to increase overall tax revenues. The federal estate tax was first put into place in 1916. Back then and for many decades since, the step-up in basis made some logic in that it was often difficult to track down original basis on family assets. Today, cost basis information can be retrieved in seconds. We certainly are not supporting this possible change, but we understand it. It could produce billions of dollars in additional capital gains taxes- especially for wealthy families who might have to pay “ordinary” income tax rates on capital gains, as indicated above.
If both parts of the Biden estate tax plan were in place when you or your loved one died, almost every family with assets would have some estate tax and/or capital gains taxes to pay. Hence, you should be looking at your overall estate planning now. As we mentioned above, legislation will likely be made later in the year. It could be made effective retroactively to January 1, 2021.
Meet with your estate attorney and a total wealth manager, like DWM, to assess your situation, review strategies, make plans and get them implemented. We did a fair amount of this planning in late 2020 with some clients and we expect to do a great deal more early in 2021. No one knows what the changes will be and when they will become effective- 1/1/2021, mid 2021 or 1/1/2022. Even so, the worst plan is likely no plan.
Hope to talk with you soon!
Detterbeck Wealth Management is a fee-only financial planning / wealth management company with offices located in Palatine, IL (Chicago area) and Charleston, SC areas serving clients locally and across the country. To contact us about setting up an appointment, please see our contact us page