It’s taken a few days longer than expected, but early this morning, every major news network called the 2020 election in favor of former Vice President Joe Biden, who will become the 46th President of the United States. This news appears to have not been particularly well received by the 45th President, the incumbent Donald Trump, who has shown no signs that he’ll concede any time soon, choosing instead to launch allegations of voter fraud and promise legal action.
Eventually, this whole thing will get sorted out. And once the legal process is complete, if it does indeed reveal that Biden is next in line, many Americans will be asking the same question: are my taxes going to change?
It’s a valid question, because Biden has not hidden the fact that he intends to raise taxes by nearly $3.5 trillion over the next ten years on corporations and individuals earning more than $400,000 annually. As a result, high earners have a right to be nervous about a Biden presidency. At the same time, Biden has proposed a package of incentives aimed at cutting taxes for lower-income taxpayers, including refundable credits for everything from paying childcare costs to buying a home. Thus, for some, news of a Biden victory could mean more money in their pockets come tax time.
But will the tax hikes and cuts come to fruition? Interestingly enough, the answer to that question is the same answer you’ll get to any meaningful tax question: it depends. Because while Biden may soon be in command, the fate of his tax proposals rests in the hands of two January elections in Georgia.
You see, Democrats currently own a majority in the House of Representatives. The Senate, however, remains unresolved: as of this writing, 50 of the 100 seats belong — or will soon belong — to Republicans, with 48 more in the hands of Democrats or independents who caucus with Democrats. The remaining two seats — both in Georgia — will be decided in January runoffs after none of the candidates for either seat was able to obtain the 50% of votes necessary under Georgia law to claim victory.
And those two seats are critical to Biden’s ability to implement his tax proposals. If Republicans retain even one of the two seats, it’s extremely unlikely Biden will be able to get any of his proposed changes past the Senate, where bills generally require 60 votes for passage. With only 49 Democratic Senate seats, Biden would need 11 Republicans to cross the aisle and support his plan to raise taxes on the rich, which ain’t going to happen. And as for implementing his tax cuts for low-income taxpayers? Well, if history has taught us nothing else, it’s that Senate Republicans are about to get VERY opposed to adding a penny to the deficit.
But if the Democrats can win BOTH Senate seats in early 2021, the game changes significantly from a tax perspective. Why, you may ask? After all, 50 seats is only one more than 49 (Ed note: this is true); if Democrats were going to need 11 Republicans to cross the aisle in order to get 60 votes with one victory in January, how do things really change if they suddenly need only 10?
Oh, they change all right. If Democrats sweep both seats and get to a 50-50 split in the Senate, there is nothing stopping President Biden from putting his stamp on the tax law. He could pass his vision of tax reform without a SINGLE VOTE from a Republican.
This is made possible by a little thing called “Budget Reconciliation,” a streamlined process for passing bills that comes in particularly handy when the same party controls the White House, House of Representatives, and the Senate. As part of the process, when a bill gets to the Senate, instead of needing the standard 60 votes for passage, it instead requires only a simply majority, 51 votes.
Of course, at best, Democrats can hold only 50 Senate seats. That matters not; in the event of a 50-50 tie, Vice President-elect Kamala Harris would cast the tie-breaking vote, and that vote is only going one direction.
Budget Reconciliation can only be used for bills that impact revenue or spending, so tax proposals are fair game. For proof of that fact, you need look no further than the 2017 Tax Cuts and Jobs Act, a $1.5 trillion tax cut passed by President Trump without a single vote from a Democrat by using reconciliation.
Of course, Biden would have zero margin for dissent; if even a single Democratic didn’t support his tax plan, it would fail. And lest you think these types of votes ALWAYS pass along party lines, go back and review what happened when President Trump attempted to repeal Obamacare using the reconciliation process shortly after winning the White House. Defections happen.
But if everything falls in place: If Democrats win both Senate seats, and then the House and Senate pass a joint budget, earmarking the reconciliation process for a tax bill, and then draft up a tax bill, there would be nothing the Republicans could do to stop it.
And since that possibility is still in play, perhaps we should remind ourselves exactly what it is Joe Biden has proposed. Let’s take a look...
Biden has made no secret of his desire to raise nearly $3.5 trillion in additional tax revenue, though he has repeatedly assured voters that those earning less than $400,000 annually will not experience any increase in their tax bills. What would he change?
Top Rate On Ordinary Income
Current Law: As part of President Trump's signature legislation — the Tax Cuts and Jobs Act (TCJA), passed in 2017— the top rate on ordinary income — things like wages, business income, and interest income — was reduced from a high of 39.6% to 37%. Of course, the U.S. tax system is a progressive system, meaning we pay higher rates as our income increases. Under the current structure, those rates begin at 10%, and then climb to 37% via the following steps: 12%, 22%, 24%, 32%, and 35%.
Biden's Plan: Biden has proposed raising one – and only one – of the seven tax rates: the top rate of 37%. This 37% rate, which currently kicks in for single taxpayers with income in excess of $520,000 and married taxpayers with income in excess $620,000, would jump to 39.6%.
Top Rate on Long-Term Capital Gains and Qualified Dividends
Current Law: Long-term capital gains (think: the sale of stock held more than one year) and qualified dividends are currently taxed at a high of 20%, though most American's pay 15%, with those in the 10% and 12% brackets paying 0%.
Biden's Plan: Biden would increase the top rate on long-term capital gains and qualified dividends from 20% to 39.6% for taxpayers earning more than $1 million. Thus, if your income is less than $1 million (it is), you need not worry about this increase.
Current Law: If you earn money through wages or are self-employed, you pay payroll taxes. In the employer-employee context, the employer and employee split a 12.4% tax on earnings up to the Social Security wage base, which in 2020 is $137,700 For ALL wages, the employer and employee split a 2.9% Medicare tax. If you're self-employed, you're on the hook for the full 15.3% (though you do get to deduct half of the taxes on your return). Finally, as part of Obamacare, those who earn more than $250,000 (if married, $200,000 if single), are subject to an additional 0.9% payroll tax.
Biden's Plan: Biden has promised to secure the solvency of the Social Security fund by lifting the cap on the Social Security payroll tax, but once again, ONLY ON WAGES IN EXCESS OF $400,000. This would create a donut hole: an employee paid a $500,000 salary would pay the 6.2% Social Security tax on the first $137,700, no Social Security tax on wages from $137,700 to $400,000, and then another 6.2% tax on the wages between $400,000 and $500,000. He or she would also pay the 1.45% Medicare tax on all wages and the 0.9% Obamacare tax on wages over $250,000 (if married).
Elimination of the 20% Qualified Business Income (QBI) Deduction
Current Law: The TCJA allows taxpayers who operate businesses as an S corporation, partnership, or sole proprietorship to claim a deduction equal to 20% of the qualified income earned in the business. This reduces the effective top rate on this type of income from 37% to 29.65.
Biden’s Plan: Biden would phase-out the deduction for those taxpayers with taxable income in excess of $400,000.
Current Law: Taxpayer are entitled to deduct the greater of 1) the standard deduction, or 2) the sum of the itemized deductions (things like mortgage interest, medical expenses, state and local income and property taxes, and charitable contributions). The TCJA nearly doubled the standard deduction (from $6,350 to $12,400 for single taxpayers, $12,700 to $24,800 for married couples), while limiting or eliminating certain itemized deductions, a confluence of changes that decreased the number of filers who will itemize from 30% in 2017 to 11% in 2018.
While certain itemized deductions are subject to limitation — for example, the deduction for state and local income and property taxes is capped at $10,000 — there is no longer any overall limitation on a taxpayer's itemized deductions as there was prior to 2018.
Biden's Plan: Biden would make two changes to itemized deductions. First, for those earning in excess of $400,000, he would reinstate the Pease limitation. This provision, which was eliminated by the TCJA, reduces a taxpayer’s total itemized by 3% for every dollar that income exceeds $400,000.
In addition, Biden would cap the benefit of itemized deductions at a 28% rate. At first blush, this could run afoul of Biden’s promise to prevent tax increases on any taxpayer earning less than $400,000, because, for example, a single individual who earns $200,000 currently pays a top rate of 32%. Thus, if the 28% limit were applied to this taxpayer, he or she would pay a 32% rate on their last dollar of income, but receive a 28% deduction from their last dollar of, say, mortgage interest expense or charitable contribution. That, of course, would amount to a tax increase.
To prevent this result, Biden has promised that the 28% benefit limitation on itemized deductions would not kick in until income exceeds $400,000.
Current Law: The hallmark of the TCJA was the reduction in the corporate rate from 35% to 21%.
Biden's Plan: Biden would raise the corporate rate to 28%. In addition, he would implement a new form of the “alternative minimum tax” by requiring corporations with financial statement income in excess of $100 million to —at the very least — pay tax of 15% on its financial statement income.
Current Law: When you die, the value of your assets (your estate) is taxed at a rate of 40%. Well, not YOUR estate, because only total assets worth more than $11.58 million are taxed, and to put this delicately, you do not currently reside in that neighborhood. More importantly, when you die, your heirs take your assets with a “stepped-up” basis equal to their fair market value; thus, while the VALUE of the assets may be taxed, any appreciation in the assets will not be taxed when they transfer from decedent to beneficiary.
Biden’s Plan: Biden is proposing sweeping changes to the estate tax regime. The rate would rise to 45%. The exemption would drop to $3.5 million. And death would suddenly become a realization event — any appreciation in your assets would be taxed upon your demise.
Summary of Tax Increases:
According to the eggheads at the Tax Policy Center, Biden’s tax increases would result in a reduction in after-tax income for those earning between $400,000 and $790,000 of about 2.4%, for an average tax hike of $9,000. Those who earn more than $790,000 (the “one-percent” so to speak) will experience a much larger increase, amounting to a 16% loss of after-tax income and an average increase of $265,000. The biggest reason for the incremental jump is the near-doubling in dividend and capital gains tax rates that applies only when income exceeds $1,000,000, as well as the changes to the estate tax.
Biden’s plan isn’t all about tax increases. He has also proposed a number of cuts, in the form of additional tax credits. Credits are better than deductions, because 1) they reduce tax liability dollar-for-dollar, and 2) they are often refundable, meaning even if you don’t owe taxes, the credit will increase the size of your refund.
Biden is proposing a bevy of new credits, including:
An expanded child tax credit. The credit, which currently tops out at $2,000 — with only $1,000 of that amount being refundable — would be increased to a maximum of $3,600 per child and would become FULLY refundable.