With the Democrats holding a majority of the Senate, assuming Vice-President Kamala Harris’ tie-breaking vote, we should expect to see some action on President Joe Biden’s tax plan.

Biden’s tax proposals to date have been quite progressive, primarily focusing on traditional redistribution of tax – higher taxes on income and estates for wealthy individuals. The President also proposes a number of credits and deductions aimed to provide relief for middle- and lower- income families. It is not clear at this time whether the proposals will have the desired outcome, or potentially create a heavier tax burden for all Americans.

Tax the Rich, Credit the Poor and Middle-Income Earner
The Tax Cuts and Job Act (TCJA) of 2017 reduced the top income tax rate to 37%, a drop from 39.6%. However, this reduction only lasts through 2025 when the TCJA expires. Biden’s plan would expedite that reversion, moving rates back to 2016 levels, and bring back the 28% cap on itemized deductions which was also repealed by the TCJA through 2025.

Biden’s proposals increase capital gain rates, taxing long term gains and certain dividends at ordinary income levels (39.6%) for those with income over $1M. Income from carried interests is also likely to be taxed as ordinary income, whereas the TCJA provided lower capital gain rates for carried interests held for more than 3 years. The Obama-era 3.8% net investment income tax for earners over $200K ($250K for married couples) would not be eliminated, potentially increasing the top capital gains rate to 43.4% for those with income exceeding $1M.

Other tax increases on high earners include a 12.4% Social Security tax, split between employers and employees earning over $400K, and the phase-out of qualified business income (QBI)/199A pass-through deductions. This could prove particularly costly for the self-employed, who bear both the employee and employer portion of the tax. However, a revision to Social Security could not be achieved through a 51% reconciliation of the Senate and is unlikely to get the 60 Senate votes it would need to pass.

In addition to an increase in tax for the wealthy, Biden’s plan seeks to provide savings for lower income earners through a series of deductions, tax credits, and incentives. Middle class tax incentive proposals include expansion of the child tax credit to $3,000 per child ages 6-17 and $3,600 for children under 6. Biden has indicated this credit would be temporary but would remain “as long as economic conditions require.” Additional proposals include an increase in the child tax credit to $8,000 for one child and to $16,000 for two or more children. A new tax credit of up to $5,000 is proposed for family caregivers, but would likely be income-capped.

Biden has suggested tax credits incentivizing real estate activity: a tax credit of up to $15K for certain first-time home buyers, a credit for rehabilitating properties in distressed areas, and a renter credit to cap rent and utilities at 30% of qualifying low-income households. At the same time, certain real estate tax breaks would be eliminated including the $25K exemption for passive rental real estate losses, Section 1031 like-kind exchanges which defer capital gains, expedited depreciation for certain real property interests, and QBI deductions for real estate activities.

Potential “green” incentives include a full tax credit for the purchase of an electric car, and continuation or expansion of tax credits for energy efficient improvements and solar investments in real estate. Biden looks to expand tax incentives for real estate investments that reduce carbon emissions, as well as eliminate tax deductions for oil and gas drilling expenses and depletion.

Enticing Retirement Savings
Biden hopes to make retirement savings easier and more attractive for lower and middle income earners, who have a harder time putting those funds aside. These proposals include a 26% matching tax credit for every dollar contributed to a retirement plan, and allowing family caregivers who have not earned income to be contributed to a retirement account, to make catch up contributions when out of the workforce for more than a year due to family caregiving responsibilities. The creation of additional opportunities for automatic IRAs for those whose employers do not offer plans would bolster utilization of this opportunity.
The proposed 26% credit would be enacted alongside an elimination of the deduction for contribution to employer plans and IRAs, incentivizing lower and middle income earners, and reducing the benefit of retirement savings for high earners. For example, whereas currently a high earner would see up to a 37% tax deduction for every dollar contributed to a qualified plan and a low earner would only yield a 10% tax deduction (based on their tax brackets), the new plan would provide a 26% credit across all brackets.

Estate Tax Possibilities
Estate tax has been a problem only for the wealthy for many years. While Biden has not articulated a clear plan for estate taxes, he has suggested a return to the estate tax levels of 2009 – a $3.5M exemption and a top rate of 45%. The federal estate tax exemption is currently at $11.7M in 2021 with a 40% top rate, set to revert to $5M in 2026. It was estimated that only .07% of decedents in 2019 would be subject to federal estate tax. If exemption levels are reduced to 2009 figures, a great many more estates will be subject to tax.

More troubling for middle class estates, Biden has also suggested eliminating the step-up in cost basis for inherited assets, but the details remain unclear. Earlier Obama administration proposals had included a $100K limit on capital gain that would be portable between spouses, allowing for $200K of capital gain step-up in estates. A loss of the step-up in basis would be a particularly devastating blow to middle America, as almost all wealth passing to the next generation would become subject to gain, taxing the growth on legacy assets, including real estate and equities held for decades, or even generations. Coupled with the CARES Act tax implications for beneficiaries inheriting qualified retirement accounts, beneficiaries could be looking at a significant piece of their inheritance going to the government.

It remains to be seen whether Biden will be successful in enacting his tax plan. We do not believe all aspects will be the slam-dunk one might expect with single-party majorities in both the House and the Senate. Given the potential burden to the middle class, it is particularly likely that changes to the estate tax and the elimination of stepped-up cost basis will be the subject of significant wrangling. We will keep you updated as legislation begins to take shape.