Taxes, Taxes, Taxes

David K. Little, CFP®, CFA

It’s no secret that the current administration in Washington has big spending plans that it would like to see passed.  It’s also no secret that they’re trying to find a way to pay for these plans, and that tax increases will probably contribute most of the revenue they’re trying to raise.

While details are still sketchy on the potential tax increases, there are proposals floating around that we can use to give us an idea about what MIGHT happen.  Remember that this is all in a very preliminary stage and that things will most likely change (possibly in large and unexpected ways) as politicians weigh in and negotiate on the issues.

With all that said, here are a few of the changes that could come to pass later this year.  You know your own situation, and based on the numbers below, you can see if they might apply to you.  Most of the changes apply primarily to folks with more than $400,000 in income, but some of the rules can apply to other people at times.

Social Security Tax Increase

For workers making more than $400,000 per year, one of the most dramatic potential increases is a change in the way Social Security taxes are assessed.  Currently, Social Security tax is assessed at a rate of 6.2% to the employee and 6.2% to the employer on wages up to about $138,000.  After a worker exceeds that $138,000 amount, the 12.4% combined tax disappears.

One of Joe Biden’s campaign proposals was a reinstatement of the Social Security tax on income over $400,000.  So, while there would be no SS tax on income between $138,000 and $400,000, after wages exceeded the $400,000, there would be a “new” 12.4% combined tax.  A worker earning $1,000,000 per year would see an additional tax of about $72,000.

Income Tax Rate Increase

Another potential tax increase involves the top income tax bracket, which currently sits at 37% on taxable income over $628,000 (married couples) and $523,000 (single tax payers).  Biden’s proposal on this involves increasing the top tax rate from 37% to 39.6%, where it resided prior to the 2017 tax law changes.

The impact to high income taxpayers with this is less severe than with the Social Security tax increase, although note that this rate increase applies to all income, not just earned income.  So pensions, IRA distributions, rental income, etc. could be subject to this higher tax rate.  Using the prior example of someone with $1,000,000 in taxable income, the total tax increase would be approximately $10,000 (2.6 percentage point increase on $400,000 of income).

Capital Gain Tax Increase

One of the proposals receiving a great deal of attention is an increase in capital gain rates.  Currently, capital gains are taxed at either 0%, 15%, or 20%, depending on the taxpayer’s income level.  There’s also a 3.8% surtax on gains if income exceeds about $200,000.  So currently, the top federal capital gain tax is 23.8% and that applies to incomes over about $450,000.

Under the proposed change, the portion of capital gains that drives a taxpayer’s income over $1,000,000 would be taxed at ordinary income tax rates.  Assuming the income tax rate increase discussed above passes, this would mean that the top capital gain rate would move from 23.8% to 43.4% (39.6% plus the 3.8% surcharge), an increase of about 20 percentage points.

Estate Taxes

Aside from income tax changes, there are proposals involving increasing estate taxes (by lowering the amount of assets someone can leave to their heirs from about $12,000,000 to about $3,000,000, and increasing estate tax rates), eliminating the step-up in basis benefit that currently applies to someone who passes away, and a “deemed sale” rule, which would assess tax on unrealized capital gains at someone’s death.  This deemed sale provision would cause taxes to be assessed at death on assets people own that have gone up in value, regardless of whether those assets are actually sold or not.

Many of these changes may not affect you or people you know at all.  Some of them might affect you dramatically on an ongoing basis.  And some of the changes may not apply to you in “normal” years, but might affect you greatly if you decide to sell a business, a piece of real estate, or even your primary residence.

If you have questions about anything raised here and how it might apply to you, please feel free to reach out to your advisor or schedule a 15-minute discovery call.  We have tools available that can help you plan around these potential new rules, or at least give you an idea of what might happen should the proposals pass.  There may also be time to take action to minimize taxes depending on WHEN a new tax bill becomes law.