Joe Biden has a tax plan, of sorts. He has made discrete proposals at different times that combine to create a progressive overhaul for upper income taxpayers. All of this is a long, long way from saying any of it will become law.  Never mind the election this November—very few Presidential tax proposals make it through the Congressional sausage machine in anything like their original form.  The Trump administration’s 2017 tax bill was an aberration in that regard.  Still, many tax proposals percolate for years before being enacted—some of what Biden has proposed may eventually become law.  What follows are some proposed changes to taxes affecting individuals. 

The Big Picture.  Following the 2017 tax act, the effective tax rate on those with million-dollar annual incomes was less than that on the lower fifty percent of taxpayers.  The Biden tax plan doesn’t directly repeal the 2017 law.  Instead, it focuses on increasing specific taxes on high earners.  Most of these apply at annual incomes of $400,000 or more; some kick in at the $1 million level.

Proposal One: Rejigger Social Security Taxes.  Social Security tax of 6.2% comes out of the first $137,700 (for 2020) of earned income, with the employer paying a matching 6.2%.  That wage cutoff effectively drops the tax rate on higher earners by 6.2%; it also means lower income workers often pay more in Social Security taxes than income taxes.

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The Biden plan restores the Social Security tax at earned income above $400,000.  This would create a donut, where the wages of the wealthy (but not wealthiest) workers remain partially exempt from Social Security, just as they are today.  It would also inject some additional funds into shoring up Social Security.  Note that the current Social Security salary cap is inflation adjusted.  The $400,000 restoration level would not be.  Thus, the donut would shrink a bit annually.

Proposal Two: Equalize Taxes on Earned and Unearned Income. Under a progressive tax code, the more income you have, the higher the marginal rate on the next dollar of income you make.  However, the highest tax rate on ordinary income is 37 percent, whereas the highest tax on qualified dividends and capital gains is 20 percent.  This means that the greater proportion of your total income from those dividends and capital gains, the lower your overall tax rate may be.  This has been borne out by recent tax filing statistics.  In 2017, those reporting income of $2-$5 million paid 27.8 percent of their income in federal taxes.  Those reporting income of $5-10 million paid 27.4 percent, those reporting more than $10 million paid 24.3 percent.  

For decades, some tax policy wonks have argued that the rate differential between ordinary income and capital gains creates distortions in investments and consumes legal and accounting resources better spent elsewhere.  Consistent with this analysis, the Biden tax proposal would eliminate the rate distinction between earned income and capital gains for those making $1 million per year or more.   The plan would also raise the top tax rate back to its pre-2017 rate of 39.6 percent.  The combination could effectively double the marginal tax rate on millionaires.

Proposal Three: Limit the Value of Itemized Deductions and Tax Expenditures.  The 2017 tax law drastically reduced the number of taxpayers who itemize deductions by doubling the standard deduction, limiting to $10,000 the amount of state and local taxes included in itemized deductions, and reducing deductible mortgage interest.  It also eliminated several deductible expenses altogether.  Unrestricted itemized deductions are basically limited to charitable gifts and investment interest.  

The Biden plan would limit the value of itemized deductions to 28 percent of income, even if the taxpayer is in a higher bracket.  This resembles pre-2018 law, which also clawed back the value of itemized deductions for higher income taxpayers.  

There are also proposals—not fully fleshed out—to limit the value of so-called tax expenditures for higher income taxpayers.  These include the exclusion from income of employer-paid health insurance, the tax benefits of retirement and college savings plans, the aforementioned capital gains preference, and others.  The Congressional Budget Office has calculated that over the past decade, these tax expenditures resulted in $12 trillion of lost tax revenue.  They almost entirely favor the wealthy—nearly 60 percent of them go to the top 20 percent of income earners, and almost a quarter go to the top one percent.  

Proposal Four: Reduce Estate Tax Exemptions and Eliminate Basis Step-Up.  The 2017 Tax Act doubled the amount each person can leave at death before paying estate tax.  That currently stands at $11.58 million this year—a married couple has twice the exemption.  That doubled exemption is scheduled to expire come 2026.  The Biden plan would accelerate the exemption’s halving.  Very few Americans would pay estate tax, even at the reduced exemption amount.

Today, most assets receive a basis step up at death, to fair market value.  This allows heirs to sell what had been highly appreciated assets at little or no tax cost.  This tax benefit goes overwhelmingly to the wealthiest families.  Depending on the version you read, Biden’s plan would either eliminate the basis step up or tax those unrealized capital gains at death—the former iteration is the more likely.  It is unclear how extensively this will apply.  For example, will some dollar amount of assets get a stepped-up cost basis and only the excess not?  Others have offered that proposal.

Eliminating the basis step up at death was tried once before, in the mid-1970s.  It was a resounding failure, largely because records of original cost basis were few and far between.  Since then, technology has solved much of that problem.  For instance, for the past decade brokerage firms have been required to track and report securities’ cost basis.

Proposal Five: Expand Tax Benefits for Middle and Moderate Incomes.  The Biden plan would direct some of the extra Social Security taxes collected to provide enhanced benefits to low-income seniors.  Forty-three percent of unmarried seniors (largely female) rely on Social Security for 90 percent or more of their income, so increased benefits would have a significant impact.  The plan would also expand the Earned Income Tax Credit to cover these seniors.  It would also expand the Child and Dependent Care Tax Credit and increase incentives for low and middle income taxpayers to save for retirement.

Not Proposed (Yet): Financial Transactions Tax.  Some Democrats, including Michael Bloomberg during his brief presidential run, have proposed a small tax on every security sale and purchase.  It would work out to $10 on a $10,000 transaction, for instance.  Proponents estimate it could raise almost $800 billion over ten year.  They also claim it would be progressive, voluntary, and discourage short-term trading.  Watch to see if the Biden campaign picks up on this proposal.

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In light of this, what is an investor to do?  For now, maximize 401k and IRA contributions.  Consider accelerating charitable contributions and making family gifts.  It’s not too early to consider some other contingent planning. Post-election, consider whether the results warrant implementation steps.  Don’t let the tax tail wag the dog—if a plan makes no economic sense outside of tax savings, it’s likely not worth the candle.

Note: Claire E. Toth, JD, MLT, CFP™, is Vice President and Chief Operating Officer at Point View Wealth Management, Inc., a registered investment advisor at 382 Springfield Ave., Summit. Visit us at  ptview.com.

Point View Wealth Management is an SEC-registered investment adviser and part of Peapack Private Wealth Management. For over 25 years, Point View Wealth Management has been providing customized portfolio management services and comprehensive financial planning solutions for individuals and their families to develop and achieve their financial goals. 

Contact us at 908-598-1717 or firm@ptview.com for more information and or to arrange a complimentary consultation.

Point View Wealth Management is located at 382 Springfield Avenue, Suite 208, in Summit.

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