Benjamin Franklin famously wrote in 1789, “Our new constitution is now established, and has an appearance that promises permanency; but in this world nothing can be said to be certain, except death and taxes.”
I don’t know about you, but I choose taxes over death, though it is a narrow margin of victory. The founding fathers knew that there would always be a need for taxes in order to pay for those necessary items that are for the good of the country.
Over the years, we have seen much speculation and quarreling over the definitions of necessary and good, and that is certainly on display as the current administration formulates their spending and tax plan.
Let’s look a little closer at the various spending/taxing items that have been proposed or passed since President Joe Biden took office, along with our predictions on whether the bills will pass (predictions represent the opinion of Waddell & Associates and are not based on any third-party information source).
American Rescue Plan Act of 2021 – Already been signed into law. This $1.9 trillion COVID-19 stimulus package provided $1,400 stimulus payments to eligible taxpayers, extended unemployment benefits, expanded child tax credits and pumped up the rollout of the coronavirus vaccine efforts.
Expanded deductibility of state and local taxes – 99% probable. This would remove the $10,000 cap for state and local income tax that was passed under the TCJA during the Trump administration.
Increase of top marginal tax bracket to 39.6% -- 99% probable. This was the top rate during the Obama administration and is just 2.6% above the current top rate of 37% passed under the Trump administration. All of the other Trump-era brackets would remain in effect.
Earned income over $400,000 subject to Social Security tax – 75% probable. The proposal is to leave the current income limit in ($142,800 for 2021) but would then pick back up for earned income over $400,000, basically leaving a donut hole between $142,800 and $400,000 where no Social Security tax will be assessed.
Tax benefit of itemized deductions limited to 28% -- 75% probable. This would apply to those taxpayers who make more than $400,000 annually, reducing income tax liability by no more than $0.28 for each dollar of allowable itemized deductions.
Return of the Pease Limitation – 95% probable. This limit reduces the value of itemized deductions for high income taxpayers by reducing the value of the deductions by a certain percentage when taxable income is above the “limit” amount, estimated to fall into Biden’s $400,000 rule. This was repealed by TCJA in 2017.
Capital gains taxes at 39.6% for those earning over $1 million annually – 65% probable. This would virtually double the tax rate for long term capital gains from a maximum of 20% to the ordinary income tax rate of almost 40%.
Increase corporate tax rates from 21% to 28% - 95% probable. This is a claw back of one-half of the reduction made by TCJA in 2017.
Capital gains tax at death – 60% probable. This is part of the recently introduced STEP Act. The proposal would assess capital gains tax on appreciated assets at the time of death, with a $1 million capital gains exemption plus up to $500,000 for personal residences (currently law).
As you can tell from the sample of potential tax changes I have noted above as well as the campaign promises made by the Biden administration, the intent behind these proposals is to make the wealthiest people in the country pay a larger percentage of their income in taxes. Notably, the promise has been to keep those making less than $400,000 virtually untouched.
If you are in the $400,000+ club, how can you make adjustments in order to avoid some of the new tax bite?
If you are charitably inclined, use appreciated stock or QCDs to make gifts instead of cash. Also, consider bunching donations into years of lower income to avoid limiting the tax benefits.
If you are considering selling a business, do it this year. If the sale happens in 2022 or later, consider an installment sale to lower income.
If you have a large amount of capital gains from the market recovery last year, consider harvesting them in 2021 to reset your basis.
Consider participation in a nonqualified deferred compensation plan if available.
We will certainly know more in the next six months than we do now. Remember that nothing that is proposed makes it through Congress without rewrites and lots of debate. Don’t panic, see how the tax war plays out in Washington, and consult with your trusted tax professional before implementing any strategy!
Kathy S. Williams leads Waddell & Associates as a principal, senior wealth strategist, and the director of technology at the firm. Kathy joined Waddell & Associates as its fourth employee almost 30 years ago and has been an integral part of the firm’s growth since then. During her time at Waddell & Associates, Kathy has also served as chief compliance officer. Kathy is a certified financial planner (CFP) professional and a certified divorce financial analyst practitioner (CDFA).