3 Things You Need to Understand About President Biden’s Tax Plan
President Biden has yet to make his tax bill a top priority, but with Americans likely to reach herd immunity by the end of summer 2021, people’s attention will quickly return to addressing income and wealth inequality.
Biden’s tax plan has multiple provisions that individuals, business owners, and families need to aware of. The inevitable new tax law will likely look different than his initial proposal but keeping an eye on these important areas will help you focus on where you are most vulnerable.
Income at or Close to $400,000
President Biden has not specifically addressed whether his tax plan will target families or individuals making $400,000 or more. He has made clear that if you are over that $400,000 threshold, your tax bill is going up with the top marginal rate going from 37% to 39.6%.
Current law imposes a social security tax for the employee and employer (7.65% each, 15.3% total) on wages or self-employment income up to $137,700. If your income is above those levels, social security tax is not imposed on income above the $137,700 level.
The reason for this cap is because social security retirement benefits are also capped regardless of how much money you earned over your career. Biden’s proposal would seek to impose additional social security taxes on wages or self-employment over $400,000.
Assuming that same rates applied to high earners, this represents a significant tax increase because a self-employed individual would end up paying an additional 15.3% on income earned above $400,000.
Capping the Tax Deduction Rate at 28% for Itemized Deductions
Under current law, you can itemize certain expenses, aggregate them, and deduct them from your income to lower your taxable income. If the total value of your itemized expenses is less than the standard deduction ($25,100 for married filing jointly, $12,550 for single), you would generally take the standard deduction since it is a greater amount.
The key point to understand is the deduction takes place at your marginal tax rate, or the highest tax rate at which your incremental dollars are taxed. In other words, if you are in the 35% marginal tax bracket, and you have $36,000 of itemized deductions, it reduces your tax bill by 35% * $36,000 or $12,600.
Under the proposed tax plan, you would be capped at a 28% rate. Therefore, anyone in the 32%, 35%, 37% or new 39.6% bracket would pay more in taxes. Those in the 10%, 12%, 20 or 22% bracket are unaffected.
Reducing the Estate and Gift Tax Exemption Amount
Biden’s plan halves the current $11.58 million lifetime exemption amount that applies to both gift and estate tax to $5.79 million. Most individuals have an estate of less than $6 million ($12 million for couples), but more retirees could fall into that category over time.
If your estate value is above the exemption amount, the federal estate tax rate is 40%, not to mention the state’s potential inheritance tax.
One of the easiest and simplest ways to reduce the size of your estate is through annual gifting. In 2021, each person can give $15,000 to any another person and not eat into the lifetime gift exemption. For example, a husband and wife could give $30,000 to their daughter ($15,000 each) every year to reduce the size of their overall estate.
Additionally, contributing to a college 529 plan with a grandchild as the beneficiary removes the assets from your estate. There are other, more sophisticated strategies, like the use of a Grantor Retained Annuity Trust or Irrevocable Life Insurance Trust which should be drafted by an estate planning attorney.
Keep the Tax Increase in Mind for Better Budgeting
Obviously, Biden’s tax proposal targets those making more than $400,000 per year and estates exceeding about $6 million. If your income and estate value are above or close to those levels, you will need a plan to address the potential tax increase.
In some cases, there is not much that can be done to reduce the tax bite. However, knowledge of the increase in taxes should impact your overall budgeting, savings and investing strategy.
For example, if under the new tax plan you have to pay, on average, an extra $2,000 per month in taxes, you will need to reduce your discretionary spending to ensure your saving and investment goals are not compromised.
Biden’s tax plan is another example of the importance of comprehensive planning and focusing on the things that are in your control.
Will your income suffer from the new tax plan? How will you prepare your financial plans so that your savings and investment goals are not compromised? Have you looked into ways to be in control of your finances regardless of this or other tax plans and laws? Please share with the community!