Individual taxation – raises tax on those who earn $400,000 or more

The Biden tax plan includes an increase in tax brackets for individuals who earn $400,000 or more. The top bracket will increase to the pre-Tax Cuts and Jobs Act (TCJA) rate of 39.6%. Currently, it is not known whether the $400,000 applies to single or joint filers. Those who earn less than $400,000 would remain in the same tax brackets under current TCJA rates.

Business owners – qualified business income deduction charge

The qualified business income deduction of 20% could be eliminated for business owners whose annual income is $400,000 or more. This applies to LLCs, sole proprietors, S corporations, and partnerships.

Itemized deduction change – capped

Those who are in tax brackets above 28% will be affected by this. Itemized deductions can only be taken up to a 28% tax rate. For example, if you are in a 32% tax bracket, 4% of your itemized deductions would not be allowed.

401(k) plan – credit

Instead of a pre-tax deduction, individuals will receive a flat 26% tax credit. Under the current plan, if an individual contributes to their 401(k) plan, they are effectively lowering their taxable income. For example, if you make $100,000 and contribute $10,000 to your 401(k), your income is lowered to $90,000 for federal tax purposes. This would lower your adjusted gross income. Under the Biden tax plan, if your overall income is $100,000 and you contributed $10,000 to your 401(k) plan, your overall adjusted gross income would still be $100,000. However, you would receive a tax credit of $2,600 or 26% of $10,000. This credit is favorable for those who are in a tax bracket of 26% or less but would be unfavorable for those in a tax bracket over 26%.

Increased child tax credit

Under Biden’s proposed plan, the child tax credit would increase from $2,000 for children under 17 to $3,600 for children under 6 and $3,000 for children under 17. The dependent care credit would be increased from $3,000 to $8,000 for one child and from $6,000 to $16,000 for two or more children.

Increased long term capital gains rate

Income over $1,000,000 would no longer have the benefit of long-term capital gains rates. This would be taxed at the earner’s ordinary tax rates. Instead of to 20% plus 3.8% net investment income tax rate or 23.8%, the individual would be taxed at their ordinary tax rate plus the 3.8% net investment tax rate.

Estate taxes

The Biden tax plan proposes an elimination of the step-up in basis rules under the TCJA. Under the current plan, if an individual inherits a home that was originally purchased for $100,000 and was worth $1,000,000 when they inherited it, their basis would be “stepped-up” to the $1,000,000. Say that beneficiary sold it the day after they inherited it. Their taxable income would be $1,000,000-$1,000,000 or $0. Under Biden’s proposed plan, this individual would not receive a step-up and would be taxed on $1,000,000-$100,000 or $900,000. Additionally, the estate exclusion amount will be lowered from $11.58 million to $5.79 million.

Year-end tax planning

This could be a crucial year for year-end tax planning. Individuals are strongly advised to contact their tax advisors to strategize. If Biden is elected, tax rates may increase for those who earn $400,000 or more.

Roth conversions should be considered at the current lower tax rates. The earnings in Roth IRAs grow tax-free. Some individuals should consider converting their IRAs to Roth this year to take advantage of the current lower tax rates.

Those who are not already maxing out their 401(k) contributions this year should consider doing so if they can afford it. This is especially true if their tax bracket is over the 26% tax credit that Biden is proposing.

Earners who make $1,000,000 or more should contact their advisors for strategies if they are considering selling appreciated stock. These individuals may want to consider selling the appreciated stock this year, rather than waiting and paying the ordinary tax rates that are being proposed if there is a change in administration.

Individuals who are in a tax bracket above 28% should consider strategizing their itemized deductions before the end of the year. Those who fall into a high bracket and are planning to make a charitable donation should make their donations before year-end to avoid being capped and losing itemized deductions in future years.

As always, individuals should have their estate documents reviewed for any potential updates to the tax law.