Since taxes were first imposed in 1913, they’ve gone up and they’ve gone down primarily because of different administrations in the government. Some administrations have run on a platform of lower taxes and less government, while others have run on a platform of higher taxes and more government. Some have gotten their way, and others have not because of opposing parties. Tax rates have been as low as 1% during this period of time and as high as 94%. Can you imagine living during a period of time where you had to pay 94% federal income tax?
During this time, one thing has stayed consistent. That is the overall percentage of tax that the US has collected on an annual basis. The amount has stayed steady, right around 17% of the national economy, but what hasn’t stayed steady, though, is who’s responsible for paying that 17% tax in the country. It could be in a period of high tax rates, but because of your facts and circumstances, you might be in a relatively low tax rate. Or it could be the other way around. The country could be experiencing historically low tax rates, and you’re paying more than you ever have. The biggest issue with most tax changes is there’s a group of people who benefit from the changes and a group of people who don’t.
For those who benefit, they believe the changes were the best thing since sliced bread. For those who don’t, they often think the world is coming to an end, and I’m not sure which side of the coin you’re going to fall on. However, I’m going to be covering Joe Biden’s proposed tax changes, so you can start understanding what your tax situation might look like going forward.
Everything I’m talking about is a proposed change; it has not yet happened, and some or all of it may never happen. Second, we don’t have all the details on how some of the proposed changes will actually work. I’ll do my best to provide as much information as I can, without injecting too much of my own opinion.
Number one is to impose additional payroll tax on those with W2 income and self-employment income that is more than $400,000. Currently, there’s no phase out for Medicare tax. You’re going to pay that tax no matter how much you earn on your W2. However, Social Security tax caps out at $137,700 in wages or self-employment earnings. The new proposal is to create a doughnut hole between the current limit and the $400,000 where there would be no additional Social Security tax, and then add the tax on to those who make over the $400,000 threshold.
The purpose of the tax is to provide needed funding to help stabilize the Social Security program. The problem with the proposal is there’s only 1% of the population that even makes that amount of money. Some of that 1% are business owners who can adjust what method they use to pay themselves. For example, they could stop taking as much wage and increase their distributions. Therefore, I don’t see a big benefit from this proposed change. We’re not going to see a lot of dollars coming into the tax system because of it.
Number two is to increase the top individual income tax bracket for those who make over $400,000 a year to 39.6%; their current bracket is 37% and could be as low as 29%. If they qualify for the qualified business income deduction, the argument for this increase is that the rich are not paying their fair share. The argument against it is that there aren’t enough rich people to cover the deficit they’re proposing to cover, and rich people often have the ability to hire accountants and attorneys to help them create a structure to legally avoid the tax.
Number three is to tax long term capital gains and qualified dividends at the ordinary income tax rate of 39.6% on income above a million dollars. The current tax rate on long-term capital gains and qualified dividends is 20%. The reasoning behind this increase is that everyone should pay the same tax rate regardless of the type of income they’re receiving. By making this change, it would stop rewarding the rich for investing in long-term assets, which could have a negative effect on the economy according to some experts. They claim that one of the reasons so much is invested into large real estate projects is because the tax benefits this type of investment offers.
Number four is to eliminate the step up in basis real estate gets. The law is currently structured to where if you die owning real estate, your beneficiaries inherit that property for tax purposes at the value of the property at the time of death. Under this proposed change, there would no longer be a step up in basis. This means if you inherited a piece of real estate that cost the deceased person $100,000, but the asset is now worth $500,000, you would have to pay taxes on the $400,000 of appreciation. If the step-up basis is eliminated, all income levels will be affected because most real estate transfer to death is worth more than what it was worth when it was purchased. For the high-net-worth individual who has income over a million dollars, they could end up losing the majority of the asset value between capital gains taxes and estate taxes.
Number five is to phase out the qualified business income deduction for those with taxable income above $400,000. Currently, the qualified business income deduction allows many business owners to lower their marginal tax bracket down from 37% to 29%. If this deduction were disallowed, and the top marginal tax bracket were increased to 39.6%, as it has been proposed for those making over $400,000, then there would be a percentage of the population that would see a tax increase of over 30% overnight. Those in favor of this proposed change are in favor of bringing more income equality to society by taking money from the rich in the form of taxes and giving it to the poor in the form of government benefits.
Number six is to expand the earned income credit for childless workers aged 65 and older. The purpose of this change is to use tax benefits to help reduce poverty amongst the elderly. Currently, 9.5% of the retired population live below the poverty level, and about 20% of retirees are working or looking for work. This proposed benefit would provide the lowest income earners with an additional source of income to help supplement their work earnings.
Number seven is to expand the Child and Dependent Care tax credit from a maximum of $3,000 in qualified expenses to $8,000 and $16,000 if the taxpayer has multiple dependents and increases the maximum reimbursement rate from 35% to 50%. Lower income families are struggling to figure out how they can get ahead financially and still be able to take time for their kids. This benefit would allow more parents to work without having to worry about the cost of daycare. Many of those who disagree with this proposed change use the removal of personal responsibility as their main concern.
Number eight is to increase the child tax credit from a maximum value of $2000 per child to $3000 per child, as long as economic conditions require it. There would also be a $600 bonus credit for children under age six. The child tax credit would also be made fully refundable removing the $2500 reimbursement threshold and the 15% Faison rate. Low income families with the most children will see the greatest benefit from this change. Many of those who oppose this change have two main concerns: the amount of fraud that happens when you have refundable tax credits and that if benefits get so large, it may be a disincentive for those receiving the benefits from actually trying to go out and find a job.
Number nine is to restore the first time homebuyers tax credit. A first time homebuyer’s credit of $15,000 would be provided for first time homebuyers. The cost of real estate is skyrocketing, and many lower income or younger taxpayers struggle to be able to afford a home. This credit’s designed to help those individuals get a hand up towards home ownership.
Number ten is to expand the estate and gift tax collection. By restoring the rate and exemption amount to 2009 levels, this would increase the estate tax rate to 45% and lower the exemption amount from 11,180,000 down to 3.5 million. This is once again a play to help redistribute the wealth from the haves to the have nots.
My top takeaways: First, the purpose of almost all the tax changes is to redistribute wealth. Second, government’s going to get bigger rather than smaller. Third, there will be more fraud in the tax system. This will come from those who are trying to evade taxes because they earn too much money and from those who are trying to take advantage of the refundable credits because it’s seen as free money offered by the government. Fourth, tax rates will eventually go up for everyone because tax increases don’t happen in a vacuum. There are not enough rich people to provide for all the proposed additional benefits.
Therefore, these changes continue to confirm that this zero percent tax bracket is where you want to find yourself in retirement because remember, two times zero is always zero.