Tax Planning: Anticipating Biden’s Tax Increases. What does it mean for small investors and small businesses?

Tax Planning

Keys

  • Income tax:  Under Biden’s recent proposal, the top marginal income tax rate would go up to 39.6%, from 37%.  That is where it was during President Barack Obama’s administration.
  • Capital gains tax:  The proposed capital gains tax increase more or less doubles the rate that high-earners would pay when they sell investments.  The current rate is 20%, Biden is proposing 39.6%.  That doesn’t include the 3.8% surcharge to help pay for the Affordable Care Act, making the top rate 43.4%!
  • Estate and gift tax:  It was expected that Biden would propose a decrease in the $11.7M lifetime exemption on estates and gifts, but instead he proposed eliminating a provision known as a step-up in basis upon the death of an individual.  This means that heirs would retain the deceased individual’s cost basis on inherited assets instead of receiving a step up in basis to the fair market value at death.
  • 1031 Exchanges: Biden has proposed a cap of a $500,000 deferral on the value of 1031(b) exchanges.  Anything over $500,000 of gain would be recognized as capital gain and added to basis.

Income Tax

The income tax structure is based on tax brackets.  The higher your income, the higher bracket you fall into, and the more income you have taxed at the higher rates.  Currently, the 2020 tax brackets are as follows:

Tax RateSingleMarried (Filing Jointly)Head of Household
10%$0 to $9,875$0 to $19,750$0 to $14,100
12%$9,876 to $40,125$19,751 to $80,250$14,101 to $53,700
22%$40,126 to $85,525$80,251 to $171,050$53,701 to $85,500
24%$85,526 to $163,300$171,051 to $326,600$85,501 to $163,300
32%$163,301 to $207,350$326,601 to $414,700$163,301 to $207,350
35%$207,351 to $518,400$414,701 to $622,050$207,351 to $518,400
37%$518,401 and higher$622,051 and higher$518,401 and higher

Under Biden’s proposal, the top marginal rate goes up to 39.6% from 37%.  However, there is more to the story.  As you can see from the brackets, the 37% rate starts when someone earns more than $518,000 or a couple more than $622,051.  Biden’s proposal moves the income down from $518,000 to $400,000 a year, which was where it was during part of the Obama administration.

What does this mean for small investors and businesses?  It means that if you have the ability to determine when you collect income, you could accelerate your income now when the rate is lower.  You could also put off deductions now that you could take later.

Other tax planning tips include negotiating a future payment early, or converting an IRA to a Roth IRA in order to pay the lower taxes now.

Capital Gains Tax

The long-term capital gains tax structure is also based on a tax bracket.   Again, the higher your income, the higher bracket you fall into, and the more income you have taxed at the higher rates.  Currently, the 2020 tax brackets are as follows:

2020 Long Term Capital Gains Tax Brackets

Tax Bracket/RateSingleMarried (Filing Jointly)Head of Household
0%$0 – $40,000$0 – $80,000$0 – $53,600
15%$40,001 – $441,450$80,001 – $496,600$53,601 – $469,050
20%$441,451+496,601+496,601+

The current top rate is 20%, and Biden has proposed increasing it to 39.6%.  Add on top of both rates the 3.8% surcharge to help pay for the Affordable Care Act, and the top rate becomes 43.4%.

The proposal not only affects those high-earners that sell investments, but it also affects people who have a one-time, big-dollar event – like selling a family business, or the family home.  This planning opportunity is critical for those close to retirement that are depending on selling their business for retirement purposes.  The planning opportunity is there again for accelerating capital gain income while the rates are still low.

Estate and Gift Tax

While the expectation was for Biden to lower the level of estates and gifts that are exempt from tax (currently $11.7M) and to increase the estate tax rate, the president’s recent proposal left those items untouched.  Instead, Biden proposed eliminating a provision that values the assets in someone’s estate at whatever they were on the date of death.  That provision, known as the step-up in basis, would wipe out years of capital gains that have never been declared.

The wealthiest will still have to worry about the limit on the estate tax exemption and the tax rate above that, but the potential loss of the step-up in basis is likely to be a bigger deal for middle-class Americans.  Their estates would be exempt from the estate tax, but their heirs would have to calculate the appreciated gains on the assets they inherited.  Biden took this into consideration, and is recommending an exemption of $1M on the capital gains of assets transferred to heirs.

This area is a much harder one for planning because it involves death, not something that many of us want to think about, and not something we can really plan for.  However, one thing to consider is how to shelter those appreciated assets.  You could consider putting them in vehicles like trusts or retirement accounts where the unrealized capital gains are less of an issue.  You could also consider donating them to your favorite charitable organization.

1031 Exchanges

A proposal that was not expected has to do with 1031 exchanges.  This is where you exchange property and defer the gain by transferring your old low basis to a new property.  Biden’s proposal limits the amount that you can defer to $500,000.  There was previously not a limit.

Investors have been able to roll gains from the sale of buildings into new buildings without ever paying capital gains taxes on them for decades.  Coupled with the step-up in basis at death, which wiped out all the gains in value of the buildings, this was a large tax break for families whose wealth rested on real estate investment and ownership.

For planning purposes, if you are considering a 1031 exchange in the future, you could accelerate that exchange while there is not limit to the amount that you can defer.

Where can I find more information?

We are here for you to answer your questions about tax planning. Please check out our tax planning service page and contact us today.