There are not enough words to describe this year, although, “apocalyptic” has passed my lips more than once. Beginning with a global pandemic, quarantines and business closures, market corrections, to the devastating fires along the West Coast, and now closing towards a tumultuous Presidential election, it has certainly been a year where resiliency and empathy are needed.
While every election year comes with its challenges, this particular election seems especially divisive. Whoever assumes office will certainly have his hands full, focusing on restoring the economy affected by COVID19 and tax policy will play a key role. Let’s look at the current tax law, and where it could potentially change under a Biden administration.
In December of 2017, President Trump signed the Tax Cuts and Jobs Act (TCJA) into law, which made significant changes to individual income taxes and the estate tax. Most notably, the standard deduction was almost doubled, and the top rate was adjusted to 37% for income over $518,400 for single filers; and $622,050 for married couples filing jointly. Biden has proposed repealing parts of the Tax Cuts and Jobs Act of 2017 by increasing the top bracket to 39.6% on income above $400,000 while keeping the other brackets, the same. Interestingly, this is not the highest income tax rate in history. During World War I, citizens saw the rate jump from 15% to 67% in 1917 and then increase again the following year, to 77%. The rate peaked in 1944 during World War II, to a staggering 94% on income above $200,000 ($2.5 million, in today’s dollars).
Under current law (TCJA), taxpayers can claim a $24,800 (filing joint) standard deduction or deduct the combined cost of mortgage interest paid (on the first $750,000 of loan principal), charitable giving, state and local taxes (up to $10,000 annually), and certain other itemized deductions. Biden’s tax plan would limit these itemized deductions in two ways. First, he would institute an overall cap of 28% on the rate against which one could take itemized deductions and second, plans on reinstating the Pease Limitation (capping certain itemized deductions for taxpayers), and taxing capital gains and dividends (currently 20%), as ordinary income, which could subject individuals with earnings over $1,000,000 to the 39.6% top rate.
TCJA expanded the Child Tax Credit (CTC is a tax credit, which means it reduces your tax bill on a dollar-for-dollar basis) in several ways. It doubled the maximum per child (16 and younger) credit amount from $1,000 to $2,000, and also increased the refundable amount to $1400. This means if your tax due is reduced to zero, you may qualify for a refund of anything left over. This credit was also extended to higher-income families by increasing the income thresholds at which the credit phases out. In addition, TCJA created a new nonrefundable $500 credit for other dependents, for whom the taxpayer provides significant financial support.
Biden would further increase the CTC from a maximum value of $2,000 to $3,000 for children 17 and under, while providing a $600 bonus credit for children under 6. The CTC would also be made fully refundable, removing the $2,500 reimbursement threshold and 15% phase-in rate.
It is worth mentioning that Biden has proposed small business owners will also be looking at phaseouts of business income deductions over $400,000, and potential restrictions on certain tax preferences for real estate. The proposals include disallowing some losses against income, and limiting 1031 exchanges, a tax-deferment strategy for real estate held as an investment.
We understand that regardless of what is said during campaigning, it takes time to reach final stages, especially tax policy, and especially during a time when higher taxes could impede recovery. In terms of your own wealth, high-net-worth individuals and families should plan to utilize the increased federal estate exemption now, because it is currently only in place until December 31, 2025 and there could be changes prior to that. Starting the conversation now and having a plan established, will help you avoid reaction driven, costly mistakes.
Always consult a qualified tax advisor regarding your personal tax situation, and a qualified legal professional for your personal estate planning situation.
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