It’s a new year with a new administration and President Joe Biden has proposed many changes that could impact your taxes. We have pulled a few of the key features from Biden’s proposals that we feel are important for you to review and think about how these proposed changes might affect your financial strategy.
It is important to note that while it seems unlikely that tax law changes would apply retroactively to the beginning of this year, Congress in the past has made mid-year changes retroactively applicable and some proposed changes could be enacted more quickly than others.
The most prominent key feature from Biden’s plan is to increase the top rate for individuals earning over $400,000 in ordinary income from 37% to 39.6% It is unclear whether the $400,000 income threshold would apply to single filers, joint filers or both. The income brackets for those with annual income levels under $400,000 will remain unaffected.
- What to consider: If you are impacted by this proposal, you may want to consider adjusting the timing of your income to keep it below $400,000 in some years.
Another feature of Biden’s Tax Plan is to cap the value of itemized deductions. For individuals with an income of $400,000 or more, the tax benefit that afforded itemized deductions would be capped at 28%, rather than the percentage tax rate applicable at higher tax brackets. The cap would apply on any and all itemized deductions – which most notably includes charitable contributions. Thus, the tax benefits of the mortgage interest deduction would also be more limited, and the payment of state and local taxes would still have the $10,000 limit. For taxpayers under the 24% marginal brackets, this proposal would have little to no impact however, taxpayers in the 32% and above brackets could see a substantial increase in their effective tax rate.
- What to Consider: If you are a high-income taxpayer, you may want to consider accelerating deductions, such as donations, into the current year to maximize them before limits put into place.
We wanted to call out one of the features that would impact High Net Worth Individuals. Biden’s plan proposes making the tax treatment of wage-earners and wealthy investors similar, thus, taxpayers whose income exceeds $1 million would pay the same rate on investment income that is applied to wages. This would change the top rate to 39.6% for individuals with over $1 million in income. Additionally, Biden’s plan proposes to eliminate the “step-up basis” that presently lets heirs avoid income on gains accumulated before death.
- What to Consider: There have been a few mitigation plans floating around that you can consider when planning. These include, taking advantage of the tax deferral of investment only variable annuities, target lower annual capital gains realized and use municipal bonds. Specifically, regarding the elimination of the “step-up basis” you may want to consider a more structured sale or gifting strategy throughout your lifetime in order to mitigate taxes for the beneficiary. We can discuss other strategies as well that might be a better fit based on your portfolio.
Biden’s proposed changes to 401(k) retirement savings plans will have a big impact on the tax break provided to 401(k) participants. If these changes were to pass, the tax deduction for contributing to a 401(k) would be replaced with a tax credit. This would likely result in high earners getting less of a tax break on their 401(k) savings and lower to middle class earners getting a bigger tax benefit. Let’s run through an example of how it works today, an employee earning $40,000 a year at the 12% tax rate can put $4,000 into a 401(k) and the tax savings would be $480. However, if an employee earned $450,000 annually at the $35% tax rate and they also put in $10,000 in a 401(k) would get a tax break of $3,500. Biden’s proposal would be that if you are making $70,000 or $450,000 the tax credit would be the same for both individuals. Biden is doing this to equalize the tax benefit of the 401(k) plans across the income scale so all families can put money way for retirement.
- What to Consider: The proposed tax credit that has been floating around is 26%. Biden’s proposal would have an effect of lowering the tax burden for anyone with an income tax rate under 26% while simultaneously increasing the tax rate for another with an income tax rate above 26%. If you have a marginal income tax rate above 26% (or plan to be in the future) you may want to consider opting for Roth-style accounts. The rules for contributions to Roth-style accounts, such as Roth IRAs and Roth 401(k)s, would be unaffected.
We have highlighted a few of the important key features of President Biden’s proposals that may impact your financial strategy. However, everyone’s financial situation is different and there are likely other aspects that we have not highlighted that that may have a greater impact on your portfolio. We are here to help you navigate the uncertainty and create a plan that you feel confident in. Reach out and schedule a meeting so we can get ahead of the disruptions, review your plan with you and stress test all of the possible outcomes. Our goal is to find solutions that make sense even within the current economic environment.