Generally, I try to avoid politics where possible, but in discussing tax and estate planning topics, sometimes that is effectively impossible. As I discovered during an invaluable learning opportunity as an eighteen year-old intern in the office of the Ranking Member of Appropriations, Dave Obey (D-Wisconsin), all tax and estate planning laws are political instruments with the goal of encouraging, discouraging and sometimes punishing certain behaviors.
I will do my best to offer an apolitical analysis of the proposals as well as discuss a few options to consider for sheltering assets should the tax laws change substantially in the coming years. In the research provided below, I only selected non-partisan or bi-partisan sources to remain as objective as possible in my analysis. My analysis will have two parts: the first will focus on proposed taxes during one’s life and the second will focus on proposed taxes at death.
Candidates rarely publish comprehensive tax plans prior to taking office for obvious reasons, so the projections and analysis below are not set in stone (Biden’s proposal was drafted in coordination with Senator Bernie Sanders (D-Vermont) once he dropped out of the primary and endorsed Biden for President). The sources I used based their analysis on Biden’s campaign rhetoric, and then further refined those assumptions based on feedback they received from the Biden Campaign on their initial analysis.
The current tax income tax rates are among the lowest in our nation’s history since the income tax was established with the 16th Amendment in 1913. Our deficits are the highest in our nation’s history, so we are left with two choices to bring our fiscal house in order: cut spending or increase taxation (or a hybrid compromise that seems ever elusive for either of our political parties). Enter the proposed changes by Vice President Joe Biden that could be enacted if the Democrats take control of both houses of Congress and the Presidency.
To cover budget shortfalls and future government spending, Biden has proposed many increases in the taxes of Americans, particularly wealthy Americans. Biden’s tax plan would increase net revenue by roughly $3.35 trillion to $3.67 trillion (akin to 1.3 to 1.4 percent of GDP). This is the equivalent of increasing revenue by almost one-tenth relative to the current law.
A detailed analysis of his proposals show a substantial rise in income tax rates, capital gains rates and estate taxes; meanwhile, the step-up in basis of assets at death will be eradicated. Biden’s platform also includes raising the payroll tax, which would adversely financially affect both corporations as well as employees, as well as raising the corporate tax rate to 28% (currently, it is 21%), but I will be focusing solely on individual taxpayer obligations.
There are lots of different ways to analyze a comprehensive tax overhaul, but for simplicity, let’s look at the two most common drivers of wealth for Americans: income and assets.
Taxation on earned income:
Per The Tax Policy Center, Biden calls for restoring the top individual income tax rate to 39.6% from 37%, and applying it to taxpayers with taxable income over $400,000 (roughly 10% lower than the current threshold). That could easily accompany an increase in rates for some of the lower tax brackets as well – though the Biden Campaign has not published defined brackets and percentages. Overall, non-partisan estimates conclude that Biden’s tax plan would increase taxes for the top one-fifth of earners by 2.3 to 5.7 percent of after-tax income in 2021 (see Fig. 4 from The Committee for a Responsible Federal Budget). The top 20% of joint household income in America begins around $120,000.
Taxation on assets:
Currently, the long-term capital gains tax rate is 20% for single households with more than $441,451 in taxable income ($496,601 for married-filing-jointly). This applies to investments held for more than one year. Biden’s policy would increase rates on long-term capital gains and qualified dividends to 39.6% — the same top rate as ordinary income — for those with income over $1 million. Obviously, that additional 19.6% means a substantial reduction in gains from investments for wealthy individuals.
Would there be increases in the long-term capital gains rates for lower tax brackets? It is unclear based on my research, and I’m fairly convinced Joe Biden has not addressed this issue as of now. That said, perhaps the increase for the highest tax bracket is also graduated (meaning the tax rate only rises to 39.6% after a certain level of realized long term capital gains).
Unlike the proposed changes to estate taxes, which require significant planning changes for a much larger demographic, increasing income taxes and capital gains taxes only further necessitates the need to avoid realizing more taxable gains wherever possible. I detail my preferred solution here, citing Charlie Munger’s first rule of compounding: “Never interrupt it unnecessarily.” Other options include Donor Advised Funds, IRAs, HSAs, 401Ks, 529 plans as well as grantor and irrevocable trusts.
In truth, because estate tax laws are rules-based, not market-based, the odds of success in adept planning are higher and more predictable than generating long-term investment returns of similar magnitude. In Part II of this analysis, I will look at the estate planning aspect of Biden’s tax policy, which is far more dramatic than what I’ve outlined above.