By: William L. Bricker, Juliya L. Ismailov, Linda Galler and Rachel Trickett
Partial Summary of the Biden Tax Plan [1]
This note will address certain of the provisions of the tax plan proposed by former Vice President Joe Biden (the “Biden Tax Plan”). The provisions of the Biden Tax Plan focused on in this article are:
Increase [2] the maximum individual marginal income tax rate from the current rate of 37% on taxable income above $622,050 to 39.6% on income above $400,000.
Social Security taxes would continue to apply to compensation up to the annual limit ($137,700 in 2020 [3]) but would also apply to compensation over $400,000. The Social Security tax rate, currently 6.2% for the employer and 6.2% for the employee, would remain unchanged. The increase in Social Security taxes would increase the effective top marginal federal income tax rate to almost 50%. [4]
Capping itemized deductions at 28% of their total value and reenacting the Pease Limitation, which reduces a taxpayer’s deductions by 3% of Adjusted Gross Income (“AGI”) over $400,000.
Repealing the preferential tax rate on long term capital gains and qualified dividends (currently the maximum rate is 23.8% -- 20% plus the 3.8% Net Investment Income tax (“NIIT”)), resulting in a maximum tax rate of 39.6% plus the 3.8% NIIT.
Phasing out the “Qualified Business Income” deduction under IRC Section 199A on income above $400,000.
Eliminating the deferral of gain through like-kind (IRC Section 1031) exchanges for taxpayers with AGI over $400,000.
Increasing the corporate income tax rate to 28%. Also imposing a 3% tax on U.S. profits of a U.S. company doing business offshore, while offering a 10% “Made in America” tax credit on profits from U.S.-based production. In addition, a 15% alternative minimum tax would be imposed on C corporations with book profits over $100 million.
Increasing the rate on certain foreign intangible low-taxed income to a 21% effective tax rate.
On the estate tax side, reducing the lifetime gift and estate tax exclusion from $11.58 million to $5.49 million or possibly as low as $3,500,000 and eliminating the step-up in basis of appreciated property.
A (Not-So) Stealth Income Tax Increase?
If the Biden tax proposals are adopted, “high-earning” (generally over $400,000), self-employed individuals and business owners could be facing the steepest tax rates in over three decade plus applicable state and local income taxes. The Tax Foundation [5] has calculated the marginal tax rates in the following jurisdictions as follows:
CA CT NJ NY NYC
Federal Tax [6] 49.338% 49.338% 49.338% 49.338% 49.338%
State Marginal rate 13.39% 6.99% 10.75% 8.82% 12.696%
SALT Deduction (28%) -3.724% -1.962% -3.010% -2.470% -3.555%
Total (w/o 28% limit) 58.91% 54.37% 57.08% 55.69% 58.48%
Total (28% limit) 62.64% 56.33% 60.09% 58.16% 62.03%
Self Employed 65.29% 59.43% 62.92% 61.10% 64.73%
There are many open issues with the Biden Tax Plan including whether SALT (State and Local Tax) deductions will be subject to the 28% limitation on itemized deductions. In addition, under the Biden Tax Plan, the actual tax rate increase is almost 13% (from 37% to 49.338%). High-income individuals, partners in partnerships or members of limited liability companies taxed as partnerships could be subject to a much higher increase due to the self-employment taxes that will inure. [7] Such taxpayers might benefit by operating as an S corporation.
A Covert Estate Tax Increase?
The Biden Tax Plan would impact estate planning in two material ways: namely, reducing the lifetime exclusion and eliminating stepped-up basis. While the details of the Biden Tax Plan remain vague, it is clear that the lifetime estate and gift tax exclusion would be significantly reduced and step-up in cost basis at death would be eliminated. It is unclear what (i) the lifetime exemption would be (the Tax Foundation believes that it would be $3.5 million), (ii) the gift and estate tax marginal tax rate will be (the Tax Foundation believes 45%), and (iii) whether the appreciation in an asset (i.e., without a step-up in basis) would be taxed when the owner dies or when the asset is later sold, exchanged or otherwise disposed of. Indications are that the gain would be taxed at death on the difference between the then prevailing market rate (i.e., fair market or “mark-to-market” value) and the historic cost basis (such gain is hereinafter referred to in this article as “mark-to-market capital gain”). [8]
A simple example can illustrate the impact of the new rules and a clear planning option:
X, a widower with 2 children, has a net taxable estate (after estate administration expenses) of $11 million and has not used any of his lifetime exemption. His major asset is a portfolio of stock that he has owned for years. His tax basis for the securities in the portfolio is $1 million and the market value at the time of his death is $10 million. Under the Biden Tax Plan, using the Tax Foundation’s prediction, there would be a $3.5 million lifetime exemption (and assuming the widower made no gifts during his lifetime leaving his entire exemption intact) and a 45% marginal estate tax rate resulting in the following tax:
Estate Tax
Net Taxable Estate: $11,000,000
Less 3,500,000
Taxable Estate $ 7,500,000
Estate Tax x 45% = 3,375,000
Income Tax
Mark-to-Market Capital Gain 9,000,000
Income Tax:
Base 39.6% 3,564,000
NIIT 3.8% 342,000 3,906,000
TOTAL TAX $7,283,000
Effective Tax Rate 66.2%
In contrast, if X made a gift of all or part of his shares to his children this year using the $11.58 million lifetime exemption currently available in 2020, there would be no gift, estate, or mark-to-market capital gain tax on the value of the shares that he gave to his children.
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[1] The Biden Tax Plan derives in material part from an undated 110-page report released on July 8, 2020 entitled Biden-Sanders Unity Task Force Recommendations. The report indicates that it was co-chaired by Former Secretary of State John Kerry and Representative Alexandria Ocasio-Cortez.
[2] While the Biden Tax Plan has no effective dates, January 1, 2021 would be the earliest effective date. Retroactive tax law changes present a Constitutional issue (See Article 1, Section 9 of the United States Constitution). Changes to the tax law adopted in a tear (2021) generally cannot be retroactive to before the bill containing the tax law changes has been introduce in Congress.
[3] For 2021, assuming no legislative change, the Social Security Administration website indicates that, based upon the statutory formula, Social Security taxes would apply to compensation up to $142,800.
[4] 52.8% = 39.6% income tax +12.4% Social Security +2.9% Medicare Tax + 0.9% Medicare Surtax - 3.02% deduction (50% of 15.3% x 39.6% rate).
[5] Tax Foundation Report is dated October 20, 2020.
[6] The Federal tax is: 39.6% marginal income tax rate; 6.2% employee Social Security; 1.45% Medicare tax (employee amount); 0.9% additional Medicare tax (0.9%) and an effective 1.188% Pease Limitation on deductions.
[7] Individuals and partners are subject to 12.4 % Social Security tax as well as the 2.9% Medicare tax and 0.9% additional Medicare tax on their earnings.
[8] Indications seem to be that the Biden camp has adopted an Obama administration proposal to impose a mark-to-market at death approach.
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